How Does LTV Affect Mortgage Interest Rate?
By Jim MichealsLTV stands for loan to value ratio. It is used by lenders as a risk measurement tool for loans. It is the loan amount divided by the property value.
What does LTV mean?
It is an abbreviation of loan to value. It is used by mortgage originators to help determine the amount of risk in a loan. The LTV is calculated by dividing the loan amount by the value of the property. It is then expressed as a percentage. The higher the percentage the higher the risk of default. As an example, a prospective borrower wants to borrow $120,000.00 for a $150,000.00 home purchase. The LTV is $120,000.00/ $150,000.00 = .8 or 80%.
Why does LTV Influence mortgage interest rate?
LTV is one risk measurement tool used by originators to set the mortgage interest rate. The higher the LTV, the higher the risk of loan default. The closer the LTV gets to 100%, the higher the interest rate. The lender may also require mortgage insurance based on the LTV.
Are there any actions a borrower can take to improve the LTV and get a lower mortgage interest rate?
Yes. There are 2 ways prospective borrowers can improve their LTV ratio. First, Increase the size of the down payment. The higher down payment will lower the loan amount needed to purchase the home. In the example above, if the borrower put another $20,000.00 towards the down payment, the loan would be for $100,000.00 and the LTV would be $100,000.00 /$150,000.00 or 67%. This results in a 16% (13/80) reduction in the LTV ratio and improves the odds for lower interest rates. Second, they can use “sweat equity” by doing some of the construction themselves. If a borrower paints the house, there is one less subcontractor to pay, lowering the loan amount.
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