A term lenders throw around a lot when talking about lending you money for a mortgage is the Loan-to-Value Ratio or LTV. This number can make or break your loan. It pertains to the value of the home and the amount of your loan. Every program has a different maximum amount it allows, which helps to determine if you are eligible or not.
The Value of your Home
The value of your home plays a role in whether or not you can secure funding. This pertains to both purchases and refinances, with a few minor exceptions in regards to refinancing your current mortgage.
When you purchase a home, the real estate agent will likely recommend that you secure a contingency that lets you out of the contract if the value is not high enough. Hopefully, the real estate agent that listed the home did his job and determined a fair value for the asking price for the home, but you can never guarantee that. The only way to truly know the value of the home is to view the formal appraisal report written by a licensed appraiser. This professional will go through the home, look at its condition and amenities and compare it to other homes in the area that sold within the last six months to arrive at its value.
If you refinance your existing home, the same procedure occurs. Most programs require you to have another appraisal performed. This way the lender can determine if there is enough money to write a new loan. This pertains to rate/term refinances as well as cash-out refinances. Of course, there is more emphasis on the value with a cash-out loan because it requires you to take cash out of the equity you supposedly have in the home. If the equity is not there, you cannot have a cash-out loan.
The exception to the rule for refinancing is when you secure a streamline refinance. This is an option for FHA and VA loans. If you strictly refinance the loan to lower the interest rate and your payment, the FHA or VA does not require a new appraisal. If, however, you plan to take a loan amount that exceeds the current outstanding principal amount and the funding fee, you will need an appraisal.
The Loan Amount
Once you know the value of the home you wish to purchase, you can determine the loan amount available to you. This varies by program. The most common maximum LTVs are as follows:
- FHA – 96.5%
- VA – 100%
- USDA – 100%
- Conventional – 97%
Let’s look at how those maximums affect you. If you wished to purchase a home for $150,000, you would need the following down payments:
- FHA – $5,250
- VA – $0
- USDA – $0
- Conventional – $4,500
Of course, you have to qualify for the loan in order to take advantage of the low down payment. Most people can qualify for an FHA loan; however, only veterans can secure a VA loan and only borrowers purchasing a home in a rural area and that have low income qualify for the USDA loan. Conventional loans, as you probably know, are the hardest to qualify for as you have to have good credit in combination with the right LTV and debt ratio.
The Loan-to-Value is One Piece of the Puzzle
The loan-to-value ratio is just one part of the equation to determine if you are eligible for a loan. If the value of the home is high enough, you are on the right path to home ownership and/or refinancing. However, you also have to have the right credit score, debt ratio, and length of employment to qualify. The lender looks at everything as a whole to determine your eligibility.
If the LTV is too high, however, there are no exceptions to the rule. You could not secure financing for a home that the loan amount is higher than the value of the home.
Working Around Loan-to-Value (LTV)
What if you really want to purchase a home whose value did not reach the right amount to secure a loan? You have one option if you still wish to purchase it, which most people would advise against – you can pay the difference. Let’s look at an example.
You signed a sales contract for $200,000 because the asking price was $205,000 and you negotiated with the seller. You qualify for financing but need to wait for the appraisal report to come back. When it comes back, the appraiser says the home is only worth $190,000. This automatically disqualifies you for every loan program above. You can get around it, however, if you put down the $10,000 difference and secure VA or USDA financing. This is not a definite approval, however, the lender has to approve the transaction; not every lender will be comfortable writing a loan for a home that you pay more than it is worth to obtain.
If you wish to secure conventional financing, you can try to get around the low appraised value by paying not only the $10,000 difference in the value, but also the down payment required for the program. Assuming you have excellent credit and a low debt ratio, you might be able to put down the minimum 3%. This would mean your total down payment would equal $14,500.
You can look at the Loan-to-Value ratio in one of two ways; it can hinder you from purchasing a property you desire or taking cash out of the home you want to refinance or it can protect you from getting in over your head. The lender does not want you to take a loan out for a home that you will have to wait a long time to see any return on your investment. Home ownership is an investment that you want to see pay off at some point in the future and it starts with securing the right LTV.
Justin McHood is America's Mortgage Commentator and has been providing expert mortgage analysis for over 10 years.