Why
loan-to-value ratio is important
When you apply for a mortgage, one of the things that lenders
want to know is what portion of the value of the home you wish
to finance. In other words, they want to know how much of a down
payment you are going to be making in relation to the overall
cost of the home. This percentage is known as the loan-to-value
ratio (LTV).
To calculate the LTV, you divide the total amount of the
mortgage by the appraised value of the property:
Mortgage ?Appraised Value = LTV
If you are buying a property with an appraised value of $200,000
and you apply for a $160,000 mortgage, then:
$160,000 ?$200,000 = 0.80 or an LTV of 80%
This percentage is important to lenders because the higher your
LTV, the lower your home equity. And lenders view borrowers with
low equity as having a greater risk of defaulting on their loan.
As a general rule, lenders require those who take out a mortgage
with an LTV greater than 80 percent, to pay for private mortgage
insurance. This protects them in the event a borrower defaults
by ensuring that the outstanding balance of the loan will be
paid off.
Lenders may also charge a higher interest rate on high LTV loans
than on loans where the down payment is at least 20 percent. And
they may require a second appraisal of a property before they
will approve the loan.
To avoid these pitfalls, it’s a good idea to keep the LTV in
mind when searching for a home. Start by getting pre-approved
for a mortgage before you go house hunting. This enables you to
calculate how much you can afford to spend.
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