The percentage found by dividing the amount of your loan by the value of your home is your loan to value ratio. Lenders will use your loan to value ratio to determine how risky your loan may be. They also use it when approving loans or requiring mortgage insurance. A lower loan to value ratio is ideal because it shows the lender you have equity in your home. Folks with higher equity generally have a lower risk of default. Additionally, your loan to value ratio describes how much of your property you actually own versus how much money you still owe.
How To Calculate Your Loan To Value Ratio
You can easily calculate your loan to value by dividing your outstanding mortgage lien by the current value of your home. E.g. Value of your home = $500,000. Your outstanding mortgage balance = $400,000. Your loan to value can be calculated by dividing $400,000 by $500,000 = an 80% loan to value. When calculating your loan to value, you must consider all loans you have on your home.
When You Need Your Loan To Value Ratio
It is important to have a loan to value ratio of 80% or lower if you are considering applying for a home loan. Otherwise, a lender may require private mortgage insurance. You will also need to know your loan to value ratio for a home equity line of credit (HELOC), mortgage refinance, or to eliminate private mortgage insurance (when you have enough equity).
If your loan to value ratio is higher than 80%, you may want to lower it before applying for a loan. You can lower it by making additional payments to pay down the principal on your loan. For folks who have a first and a second mortgage, it can be helpful to make additional payments towards the second mortgage first. This not only lowers your loan to value ratio but you can also save money from the higher interest rate second mortgages tend to have.
Combined Loan To Value Ratio
A combined loan to value (CLTV) ratio is another type of loan to value calculation. The term “combined” means all applicable additional loans are added to calculate the loan to value ratio. A combined loan to value ratio is used when there are multiple loans on a property. E.g. The value of your home is $500,000 with a first mortgage of $400,000 and a second mortgage of $25,000. Then, you will have an aggregate mortgage balance of $75,000. The loan to value ratio will equal 85%.
A combined loan to value ratio may be an option if you cannot afford the entire 20% down payment. If approved, the lender allows you to take a second mortgage out for the difference of the down payment. E.g. If you can only afford a 10% down payment, then you can take out a second for the remaining 10%. The second mortgage will usually have a higher interest rate and a shorter term. Thus, this becomes high risk for default which is why only well-qualified borrowers usually qualify for loan to values.