Legal Definitions - LTV ratio

LTV ratio stands for Loan-to-Value ratio.

The Loan-to-Value (LTV) ratio is a financial metric used by lenders to assess the risk associated with a loan. It compares the amount of money being borrowed against the appraised value of the asset that is being purchased or refinanced and will serve as collateral for the loan. Lenders use this ratio to determine how much they are willing to lend, to set the terms of the loan (such as interest rates), and to decide if additional requirements, like private mortgage insurance, are necessary. A higher LTV ratio generally indicates a higher risk for the lender because the borrower has less equity invested in the asset.

• Example 1: Residential Mortgage for a New Home Purchase

  Imagine a family wants to buy a house that has been appraised at $500,000. They plan to make a down payment of $100,000 and borrow the remaining $400,000 from a bank.

  To calculate the LTV ratio, the loan amount ($400,000) is divided by the appraised value of the home ($500,000):

  LTV ratio = ($400,000 / $500,000) * 100% = 80%

  This 80% LTV ratio means the lender is financing 80% of the home's value. Since the family has contributed 20% as a down payment, they have 20% equity from the start. Lenders often view an 80% LTV as a standard threshold; loans with an LTV higher than this typically require the borrower to pay for private mortgage insurance (PMI) to protect the lender in case of default.

• Example 2: Refinancing a Commercial Property

  A small business owner wants to refinance their commercial office building to take advantage of lower interest rates. The building was originally purchased for $1,200,000, but its current appraised value is $1,600,000. The outstanding balance on their existing mortgage is $800,000, which is the amount they wish to refinance.

  The LTV ratio is calculated by dividing the new loan amount ($800,000) by the current appraised value of the property ($1,600,000):

  LTV ratio = ($800,000 / $1,600,000) * 100% = 50%

  A 50% LTV ratio indicates that the business owner has significant equity in the property (50%). This lower LTV makes the loan less risky for the lender, which could allow the business owner to qualify for more favorable refinancing terms, such as a significantly lower interest rate or reduced closing costs.

• Example 3: Auto Loan for a New Car

  A recent college graduate applies for a loan to purchase a brand-new car. The car's manufacturer's suggested retail price (MSRP) and the dealer's selling price, which the lender uses as the appraised value for a new vehicle, is $30,000. The graduate has saved $3,000 for a down payment and needs to borrow $27,000.

  The LTV ratio is determined by dividing the loan amount ($27,000) by the car's value ($30,000):

  LTV ratio = ($27,000 / $30,000) * 100% = 90%

  An LTV ratio of 90% means the lender is financing 90% of the car's value. This is a common LTV for new auto loans. Lenders use this ratio to assess their exposure, especially since vehicles begin to depreciate immediately after purchase. A higher LTV might result in a slightly higher interest rate or require the borrower to have a stronger credit score to mitigate the lender's risk.