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Thursday, May 2, 2013

Why is a loan-to-value percentage necessary?

Mortgage downpayments affect the loan-to-value ratio
The loan-to-value ratio measures the amount of equity of a home

One of the important factors that will be considered during the mortgage process is the loan-to-value ratio. The loan-to-value is shown as a percentage and represents the amount of money being borrowed through a mortgage compared to the value of the property. Why is a loan-to-value percentage necessary?

Under normal circumstances, an appraisal of the property is always required. The appraisal is performed by a licensed appraiser who uses several tools, such as databases, to research the recent home sales in the area. The home sales must be comparable with the home being appraised. Upon a site visit to the property, the appraiser will evaluate the condition of the home, as well as, the neighborhood and surrounding homes. Pictures and measurements are also taken of the home for the appraisal. Appraisal requirements can be different based on the type of mortgage program that the borrower is applying for.

The loan-to-value is then calculated by dividing the mortgage amount by the appraised value. For example, the mortgage amount is $80,000 divided by $100,000 appraised value equals .8 or 80%. The resulting LTV is 80/20.

Down payment requirements differ for each mortgage program. VA loans have a zero down payment requirement while FHA loans require 3.5%. A higher down payment will result in a lower LTV. With a lower LTV, the lender is faced with less of a risk in the case of a default on the part of the borrower. Lenders require that the borrower carry mortgage insurance when the LTV is above 80%. When the LTV falls below 80%, either the borrower or the lender can cancel the mortgage insurance policy. 

The down payment and loan-to-value ratio is also considered when addressing mortgage rates. Lenders have rate sheets that have a multiple number of scenarios posted, including loan-to-values. Higher loan-to-value ratios usually have a premium added to the mortgage rate which means that the rate offered to the borrower will be higher.

Loan to value basically measures the amount of equity that the borrower has in the home. The LTV calculation is also used when a homeowner applies for a home equity line of credit (HELOC) and will determine how much the lender is willing to lend. In all cases, the loan-to-value percentage is necessary because it measures the amount of risk that the mortgage presents to the lender and, with this information, lenders are able to put in place several measures that ultimately reduce their risk.

About the author: Rosemary has been writing since 2010 for FreeRateUpdate.com, a company that matches consumers with banks and lenders offering low mortgage rates. Previous to her writing career, Rosemary spent 13 years working hands-on in the mortgage industry as a mortgage loan analyst, mortgage processor, property manager, and a mortgage underwriter.

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