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Why loan-to-value ratio matters to homebuyers like you
Exploring the idea of purchasing a new home is an exciting one—and full of questions and perhaps unfamiliar terms.
You may have heard a few phrases concerning a home’s purchase, like down payments, debt-to-income ratio, and co-borrower. But do you know what a loan-to-value ratio is and how it affects you as a homebuyer?
What is an LTV ratio?
A loan-to-value ratio is a formula mortgage lenders use to weigh risks before approving a mortgage. LTV ratio is calculated by dividing the mortgage amount by the appraised value of the property:
Mortgage amount / Appraised property value x 100 = LTV ratio
In other words, your LTV ratio is the part of the home’s appraised property value that is not covered by your down payment.
How is the LTV ratio used?
When your LTV ratio is calculated, lenders use that percentage to determine how risky a loan is. The higher the percentage, the riskier the loan. As a borrower, a high LTV ratio could mean higher interest rates and monthly payments.
Remember that lenders want you to be able to repay your loan and have a healthy financial outlook. Before purchasing a home, taking a homeownership course and saving up for a down payment is recommended.
LTV ratio is not debt-to-income ratio
Remember that your LTV ratio is not the same thing as your debt-to-income ratio (DTI). While your LTV ratio determines your lending risk, your DTI ratio is the percentage of your monthly debt payments compared to your gross monthly income.
Both percentages are significant to homebuyers but shouldn’t be confused with each other.
You can lower your LTV ratio
A high LTV ratio may require you to purchase private mortgage insurance to offset the lender’s risk. You can lower your LTV ratio by submitting a higher down payment and paying more towards the principal each month.
At SmartMortgage, our experienced agents are ready to help you begin your journey to homeownership.