Loan-to-Value (LTV) is a ratio that’s commonly used to help financial institutions make decisions regarding lending decisions.
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What’s the Loan-to-Value (LTV) ratio?
The loan-to-value ratio is expressed as a percentage, which lenders use to determine how risky a secured loan is.
Most lenders have guidelines, which will have a different tiers of interest rates based on the LTV ratio.
A higher LTV is associated with higher risk, while a lower percentage means lower risk. Lower risk also results in a lower interest rate because you’re more likely to pay the loan back.
Home and auto loans are two products that use LTV as part of the decision-making process because they’re secured by a home or car.
To calculate the loan-to-value ratio, you’ll take the loan amount, divide it by the value of the asset, and multiply it by 100 to get the percentage.
(Loan amount/Value of asset) x 100 = Loan-to-Value
For example, if you’re getting a car loan for $15,000 and the car is worth $17,000, then 15,000 divided by 17,000 is 0.88, and as a percentage, it’s 88%.
For a car, 88% LTV is excellent because loans are generally more than the value of the car.
How LTV is used by lenders
The loan-to-value ratio is one of several factors that lenders use to determine the interest rate for a loan. It’s one of the most important factors along with your credit score.
Usually, lenders will have tiers with an LTV percentage, credit score, and an interest rate associated with it.
For example, if you’re looking for a home equity line of credit, a lender may offer the best interest rate for anyone with a 760 or higher credit score and an LTV of 70% or less.
An excellent credit score and low loan-to-value ratio can tell a lender that you’re more trustworthy and likely to pay back the loan.
As the loan-to-value ratio increases, the risk for potential loss for the lender increases. With more risk, comes higher interest rates, and potentially declined loans.
In general, the higher your credit score, and the lower the loan-to-value ratio, the more likely it is to get approved with a lower interest rate.
Frequently asked questions
The best way to lower the LTV is to make a down payment because it’ll reduce the loan amount.
Yes, higher LTV typically means higher interest rates, while lower LTV equals a lower interest rate. Lenders have maximum loan-to-value ratios, which means if you go above it, you won’t get approved for the loan.
For home loans, 80% or less is good. For auto loans, anything under 100% is good because it means you’re paying less than the value of the car.
Understanding how loan-to-value works can be beneficial for you when it comes to home and auto loans. You’ll understand what impacts a lender’s decision on whether or not to extend credit. When it comes to car loans, you’ll know if it’s a good deal based on the loan-to-value.
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About David Em
David Em is the founder of More Money More Choices, which he launched to help you take control of your finances and build your dream life. Before More Money More Choices, David worked in leadership positions in the finance industry.