What is LTV?
As you build your real estate portfolio, you’ll encounter several acronyms that lenders and other investors use. Loan-to-value (LTV) is one of them. It’s a number that determines risk when someone takes out a secured home loan. You’ll need to understand this number—and how lenders calculate it—because it influences how much money you can borrow and how much interest you will pay on all the investments you plan to make.
In the simplest terms, the loan-to-value ratio measures the relationship between the amount of home loan you want to borrow and the value of the asset that secures that loan. An asset can be another property, vehicle, or high-value item. Nearly all lenders use LTV, so it’s one of the most important metrics when investing in real estate.
Say you want to expand your real estate portfolio and use your current investment property as collateral for a mortgage loan. Now say your property is worth $1M. Your lender might give you a loan equal to 80% of the property’s value ($800K). That’s an 80% loan-to-value. It sounds pretty simple, but why do lenders use this calculation?
Lenders need to evaluate risk before they give someone a loan. If an investor defaults, a bank might not get its money back. So loan-to-value is one way to determine the “risk worthiness” of an investor. The higher the LTV, the more risk there is for a lender, so investors end up paying more interest on a home loan over time. Investors also need to purchase private mortgage insurance if the loan-to-value on a conventional home loan—one not supported by a federal government program—is higher than 80%.
One way to lower your loan-to-value is to have a large down payment. The higher your down payment, the less your LTV will be. Lenders will consider you less of a risk if you put down a sizable amount of money on a property.
To calculate a loan-to-value ratio, divide the amount of the home loan offered by your bank by the value of your asset. Then, multiply that number by 100 to arrive at a percentage.
Loan-to-value case study
A real estate investor wants to calculate her LTV. Her bank offers her a home loan worth $400,000, and the value of her existing property (the asset) totals $500,000. Her LTV is 80% ((400,000/500,000)x100).
The bottom line
Loan-to-value, or LTV, is a calculation used by lenders to work out risk when giving investors home loans. The higher the LTV, the more of a risk there is for the lender. High LTVs mean investors will end up paying more interest over time. You can calculate the loan-to-value ratio by dividing the amount of a home loan offered by a creditor by the value of the asset that secures that loan (usually the property itself). You then multiply that number by 100 to figure out the LTV.
