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When you're applying for a mortgage, the numbers matter. So it's important to understand what everything means, which isn't always easy when you're trying to decipher industry jargon and acronyms.
One of these terms is "loan-to-value ratio", which is often simply referred to as LTV. When applying for a home loan, the LTV can make a big difference in what type of mortgage you're eligible for, your loan's interest rate and the fees you pay.
Below, CNBC Select covers how loan-to-value ratios work and why it's such an important number to understand.
A loan-to-value ratio (LTV) is a number that shows how much money is being borrowed in comparison to the value of the collateral. LTV has significant implications for mortgage applications and is expressed as a percentage. For example, if you're purchasing a home worth $100,000 and your mortgage loan balance is $80,000, you have an 80% LTV.
The LTV requirement for a mortgage depends on the type of loan and your financial situation. If you're struggling to find a home loan that fits your needs, try a lender that offers a larger variety of loan types. PNC Bank is CNBC Select's best mortgage lender for flexible loan options and offers conventional loans, USDA loans, VA loans, FHA loans and more.
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Conventional loans, FHA loans, VA loans, USDA loans, jumbo loans, HELOCs, Community Loan and Medical Professional Loan
10 – 30 years
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Calculating LTV is straightforward because you'll typically only have to know two numbers: The loan amount and the appraised property value.
The formula is this:
Current loan balance / current property value = LTV
You can change your initial LTV by increasing your down payment or negotiating a lower purchase price. Over time, your LTV will drop as you pay off the loan and the property (hopefully) increases in value.
LTV vs. CLTV
Whenever you're taking out a second loan on a property the lender will look at a combined-loan-to-value ratio (CLTV). The CLTV uses a similar formula as LTV but factors in the balances of multiple loans.
A common situation where CLTV matters is when you're getting a home equity loan or a home equity line of credit (HELOC). For these types of loans, you're typically allowed to have a CLTV of up to 80%.
If you're looking to cash out some of your home's equity to pay for a renovation, calculating your CLTV helps you figure out your rehab budget. Let's say your home is worth $350,000, you'll usually be able to borrow up to an 80% CLTV, which would be $280,000 in total. This means if your current mortgage balance is $200,000, you could finance $80,000 in home upgrades.
When it comes to mortgages, LTV affects what type of loans you're eligible for and your borrowing costs.
The LTV requirements for a mortgage vary depending on the loan type. Mortgages with smaller down payment requirements, for example, allow for higher LTVs. An FHA loan allows down payments of as little as 3.5% or an LTV of 96.5%. And USDA or VA loans can have an LTV of 100% (essentially requiring no down payment).
Conventional loans usually have stricter LTV guidelines, although certain conventional loan programs allow for an LTV as high as 97%. Just remember that with conventional loans, you'll be required to pay private mortgage insurance (PMI) if your LTV is 80% or higher.
Aside from helping you qualify for a mortgage, a lower LTV can get you a better interest rate, although other factors such as your credit score, the type of loan and the loan balance also play a role.
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The loan-to-value ratio (LTV) is an important number to understand if you're applying for a home loan. Having a lower LTV can give you access to a wider range of mortgage types and help you secure a lower interest rate. With an LTV of 80% or less, you won't need to pay private mortgage insurance, which will lower your monthly payment.