The term loan to value, or LTV, applies primarily to the mortgage banking industry. It is an equation that mortgage lenders use to assess their risk in lending a borrower money to purchase property. The equation is basically a ratio of the amount of money being borrowed to the value or purchase price of the property, whichever is less. To determine LTV of a new purchase, the purchase price or appraised value is divided by the down payment. As an example, if you were to purchase a home for $100,000 US Dollars (USD) and had $10,000 USD to apply as a down payment, the loan to value ratio would be 90%.
The purpose of establishing the loan to value ratio in the purchase of a home is to protect the lender from lending more money than the property is worth. This is why the appraised value must be at least equal to the purchase price. For consumers, the ratio weighs heavily on the interest rate you will receive on the payback of the loan. The lower the LTV, the lower the interest rate you will be given. Generally for every 5% increase in loan to value above 70%, the interest rate increases by 1/8 of a percent.
In addition, most lenders require private mortgage insurance premiums, or PMI, on ratios greater than 80%. The premium for private mortgage insurance will depend on the insurance company and the lender but can be as much as 1% of the loan amount.
Though the borrower will pay a higher interest rate on a 100% loan to value ratio, many lenders will offer this level of loan on a new purchase. However, a refinancing loan will generally not go to 100%. Lenders determine the ratio on a refinance by requiring an appraisal of the property. Usually, they can check the sale prices of comparable properties within 1 mile (1.6 km) to determine the value of the home, but in special circumstances, a walk-through appraisal may be necessary.
The loan to value ratio of a property also determines the amount a lender will give a borrower who wishes to obtain a home equity line of credit or a second mortgage. The difference between the value of the home and the amount owed on the primary mortgage is the maximum amount that can be borrowed.