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Loan to Value Explained

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Your loan to value refers to the ratio between the amount of money you borrow on the home and the value of your home. Often written as LTV, this ratio can impact the interest you pay on your mortgage loan and can, in some situations, make the difference between being granted a loan and being denied a loan.

Defining Mortgage Loan-to-Value

When you buy a house, traditionally you put a down payment on the house. Conventional wisdom suggested that a 20 percent down payment was standard, but some lenders will accept a much smaller down payment, and in some cases you may not be required to put anything down at all.

If you do put a down payment down on a home, then you are borrowing less than the full value of the home. For example, if you are buying a $100,000 home and you put a standard 20% down payment, then you pay $20,000 of the cost of your home out of your own pocket. The bank then loans you the other $80,000. Your loan to value ratio is equal to 80 percent, since the loan amount is $80,000 and the value of the house is $100,000.

Your loan to value rate may also be affected by property values. For example, if the home you want to buy is appraised at $100,000 but you are able to buy it for $95,000, then the bank still only has to lend you $95,000 on a home that is worth $100,000. In that case, your loan to value ratio would be 95 percent.

The difference between the loan and the value of the home is referred to as the equity in your home. It is the interest in the home that is owned by you, not the bank. As you pay down principle on your loan and as property values rise, your loan-to-value ratio changes. When this change is significant, it can make refinancing your home easier.

On the other hand, if you aren't paying enough to cover your interest payments or property values fall, your loan-to-value ratio can shift in the other direction. For example, if you borrow $95,000 on a $100,000 home and property values fall, the home may only be worth $90,000. In that case, your loan to value ratio would be 105 percent and it would be difficult, if not impossible, to refinance or to sell the home unless you can come up with the extra cash to make up the difference.

How Mortgage Loan to Value Affects Your Mortgage

Generally, the higher the loan-to-value percentage, the riskier the loan is for the lender. It is risky because if property values fall quickly and you end up owing more on the home than it is worth, the lender no longer has appropriate collateral in the home to ensure that their investment is protected.

Therefore, higher loan-to-value ratios usually have higher interest rates. Furthermore, most lenders will require that you pay something called private mortgage insurance (PMI) to protect their investment if you put down less than 20 percent on the home. You are required to pay this PMI each month until you have at least 20 percent equity in the home, or until your mortgage loan to value ratio reaches 80 percent.

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