Loan-To-Value (LTV) Ratio

The importance of loan to value ratio calculation in the mortgage lending process is very high, because loan to value ratio shows the percentage of loan amount that is to provide to the borrower on his loan apply. Borrower may ask for larger amount on his property but that has to be valued and estimated as per the surrounding properties. How much loan amount has to be issued depends on the borrower’s equity in that property. Banker or a lender never issues mortgage loan amount more than 80% of the equity of the property. If in any of the cases, the loan to value ratio exceeds 80% then the lender requires private mortgage insurance (PMI) from the borrower. It protects the lender from the loss in case of borrower defaults to repay the mortgage loan amount. To calculate the loan to value ratio, the lender needs to divide the loan amount with the sales prices or appraised value (which ever is less). An instance of loan to value calculation is given below:

Loan Amount $100,000

Sales Price $200,000

Appraised value $220,000

LTV Ratio = Loan amount/ Sales Price or Appraised Value (Which ever is less)

= 100,000/200,000 = 50%

In the above example the lender has no risk to take and there is no requirement of asking borrower to go for PMI. The borrower asked only 50% of the equity of the property which is less than the 80% and the appraised value is also more than the loan amount. So the lender is in a good position to provide a loan to the borrower, because even if the borrower does not repay the debt amount and walk away from this loan process, the lender can sell the property and recover the loan amount. Any excess amount out of the sale of the property returns to the borrower.

So the LTV ratio plays an important role in the mortgage loan process. Any lender provides a loan with out going for this calculation may face some problems in the recovery of loan amount.