LTV Ratio Definition
As the value of an asset decreases, whether due to economic events affecting the market for that asset or damage to the asset itself; lenders who hold that asset as collateral are less secured. That is, as the amount loaned increases in relation to the value of the asset, an investment becomes riskier. This phenomena is captured in the Loan-to-Value or LTV ratio, a financial ratio expressing the loan amount as a percentage of asset value. Higher LTV ratios indicate a riskier investment.
LTV Ratio Calculation
It is most often used by banks in assessing the amount of and on what terms to loan to a homebuyer although loans of all types often use this ratio. Lower LTV ratios are less likely to be a losing investment for a lender and therefore have lower interest rates and less stringer covenants.
LTV Ratio Explanation
If the LTV ratio is high enough, usually 80% or greater, the borrower may be required to buy purchase mortgage insurance to decrease the lender’s risk of loss in the event of a default. Ranging from an annual premium of 0.3% – 1.5% of the original loan amount each year, this insurance protects the lender in case the borrower defaults. For extremely high LTV ratios, up to 96.5%, the Federal Housing Authority offers government insured loans to further reduce lender’s risk and help those who could not otherwise afford a home purchase one.
Loan-to-Value Ratio FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.