How to Calculate Real Estate Loan-To-Value Ratio
Lenders will provide mortgages based on many factors, one being the loan-to-value ratio, or LTV, of the property. The type of property, whether owner-occupied or investment, will usually determine different maximum allowable LTV ratios. This ratio is expressed as a percentage and is derived by dividing the mortgage amount by the lesser of the selling price or appraised value.
How LTV Is Calculated
Using the selling price or appraised value of the property, determine the available or desired down payment and mortgage amount that would be needed. Let's say a home is selling at $300,000 and the buyers have $40,000 available for a down payment. Here is how to derive the desired mortgage amount:
$300,000 - $40,000 = $260,000 desired mortgage amount
Divide the mortgage amount by the selling price and convert the result to a percentage to derive the LTV ratio:
$260,000 / $300,000 = 0.87 or 87%, which is the LTV ratio.
Tips: Although you may be buying a property below the appraised value and consider it a bargain, the lender will use the lower purchase price in this calculation.
Mortgage Types and Uses
The LTV ratio is used in most qualifying processes, though it is just one of many different factors that may be considered. Of course, commercial loans have different criteria than residential loans. There are different choices for mortgages, and the characteristics will be a part of your decision, not just the interest rate and payment.
Below are some of the most popular mortgage types, and every one of them uses in some way the LTV in their qualifying processes.
Fixed Rate Mortgage
This is the basic mortgage with an equal payment every month until it is fully paid off. The simple P & I payment is made up of two components—principal and interest. As the loan is paid down, the interest component goes down each month and the principal amount goes up, adding to the equity in the property.
The most popular mortgage type is the 30-year fixed rate mortgage, followed by the 15-year fixed rate loan. The 15-year mortgage pays off in half the time with higher payments and a lot less interest paid over the lifespan of the loan.
Adjustable Rate Mortgage
An adjustable rate mortgage (ARM) is a loan with an interest rate that changes. ARMs may start with lower monthly payments than fixed rate mortgages, but keep in mind the following:
- Your monthly payments could change.
- They could go up—sometimes by a lot—even if interest rates don’t go up.
- Your payments may not go down much, or at all, even if interest rates go down.
- You could end up owing more money than you borrowed, even if you make all your payments on time.
- If you want to pay off your ARM early to avoid higher payments, you might pay a penalty.
An example would be a 7-year ARM with the interest rate to be reset seven years down the road. Depending on the rates at that time, it's anybody's guess how much the payment will be. One reason for getting an ARM other than betting on lower rates would be getting a lower payment in the first years of ownership.
Investors use blanket mortgages when they own multiple properties with equity. They can open a line of credit with a bank or get this loan by allowing the lender to use the other properties as collateral. The properties back the loan and the proceeds can be used for other investments.
Reverse mortgages are becoming popular with our aging population. For those homeowners who are approaching retirement and have significant equity, they can get a reverse mortgage that pays them a monthly payment as long as they live. The monthly payment amount is based on the home's value, equity, and age of the borrower(s).