LTV Ratio for Commercial Loans
Lenders and brokers often use a ratio called the loan to value (LTV) when considering getting a mortgage. LTV is the fraction of an asset’s value against which a lender is ready to give debt financing. It is generally represented as a percentage. LTV ratio calculation is a crucial step in the mortgage underwriting process.
What Is LTV Ratio for Commercial Loans?
LTV, or loan-to-value ratio, measures how much money is borrowed compared to how much the commercial asset is worth. It measures or assesses risk when financing commercial real estate or obtaining a commercial mortgage.
The LTV calculation is important in assisting commercial real estate lenders in determining a borrower’s eligibility and the recommended terms of the debt. Assets deemed more “valuable” as collateral typically have higher LTVs.
An asset’s suitability for use as collateral is often determined by several factors, including the stability of its value, the activity of its secondary market, and the ease with which the asset can be transferred to other parties.
A lender offers credit to customers in order to earn interest revenue. But as soon as a loan goes sideways, a lender must focus on reducing the risk of loan loss. When a lender is unable to recover all of its outstanding loan liability, a loan loss occurs.
One of the finest ways to guard against prospective loan loss is to make sure that there is a cushion between the outstanding loan amount and the price that the asset could fetch at auction or in any other place, should a borrower’s financial situation worsen and the lender needs to liquidate assets.
The fact that the borrower isn’t putting any of their money upfront—also known as having “skin in the game”—means that most lenders aren’t willing to debt finance 100% of an asset’s value. Borrowers with no skin in the game may be more prone to default on a loan obligation since they have nothing to lose.
How to Calculate LTV Ratio
To determine the loan-to-value ratio, use the following formula:
LTV= Loan Amount / Appraised Value
By dividing the loan amount by the appraised value of the property, stated as a percentage, one can determine the LTV ratio. For example, if you purchase a home valued at $100,000 and make a $10,000 down payment, you will borrow $90,000. As a result, the LTV ratio is 90%.
Implications of a High or Low LTV Ratio
The LTV ratio is a crucial statistic for both commercial real estate investors and homeowners looking for a refinance because it can significantly affect your ability to borrow money and the total cost of your mortgage. Obtaining approval for a loan with a high LTV ratio could be challenging.
Even if your application is accepted, a greater LTV ratio may result in a higher interest rate or the requirement that you purchase mortgage insurance. On the other hand, a low LTV ratio gives lenders more confidence in you. With a low LTV ratio, the cost of your loan is significantly reduced, and it may speed up the process of getting the loan.
What Is a Good LTV Ratio, and Ways to Improve Your LTV Ratio
As a general guideline, a good loan-to-value ratio shouldn’t be higher than 80%. A high LTV is above 80%, meaning that borrowers may pay higher borrowing fees, need private mortgage insurance, or even be turned down for a loan. LTVs greater than 95% are frequently viewed as unsatisfactory.
Here are some actions you can take to improve your LTV:
- Aim for a property that is more reasonably priced.
- Set up funds for a more significant down payment.
- Your loan-to-value ratio will drop when you make loan payments once you’ve obtained the loan.
Higher down payments and lower sales prices result in LTV ratios that are the lowest possible. Making a larger down payment typically results in a lower mortgage rate, even if it’s undoubtedly not something everyone can accomplish.
How LTV Ratio Affects Different Types of Commercial Mortgages
Each CRE lender and loan type has its constraints, including those governing the LTVs of the borrowers. Some even have several thresholds: one that must be met in order to avoid extra protections like mortgage insurance and another that must be met.
FHA Loans
FHA loans are loans given to homeowners directly by the Federal Housing Authority. These loans are made with the express purpose of promoting homeownership among borrowers who would find it difficult to make a down payment on a traditional loan. Under FHA loans, a loan-to-value ratio may not exceed 96.5%.
VA Loans
Government-backed mortgages known as “VA loans” are intended in particular for members of the U.S. military and veterans. Qualified borrowers can finance up to 100% of a home’s value through VA loan programs. However, borrowers are often still liable for covering closing-related fees and expenses that exceed the home’s worth when added to the purchase price.
Traditional Mortgages
Traditional mortgages adhere to the lending guidelines established by institutions sponsored by the government, such as Fannie Mae and Freddie Mac. These loans account for the vast majority of all home loans issued in the United States.
LTV limits on traditional mortgages must not exceed 80% if borrowers want to avoid purchasing private mortgage insurance. Borrowers can get up to 97% LTV if they are prepared to buy mortgage insurance and the lender improves.
Mortgage Refinances
Depending on the type of property being refinanced, whether the loan is a fixed-rate or an adjustable-rate mortgage (ARM), and whether the borrower is performing a regular refinance or a cash-out refi, different maximum LTVs are permissible.
What Does 75% LTV Mean?
A 75% LTV is one in which you pay a deposit of the remaining amount and borrow 75% of the property’s price from the lender. The remaining 75% of what you borrowed will be paid back along with interest throughout the length of the mortgage term. The median mortgage LTV threshold is a 75% LTV mortgage.
What Does 60% LTV Mean?
A 60% loan-to-value (LTV) ratio means that you must put down a deposit of at least 40% of the property’s value when purchasing a home or refinancing an existing one, with the remaining 60% being financed by the lender. You will be viewed as a less risky borrower if you have a 40% deposit, making it easier to secure a deal and possibly obtain better mortgage rates.
As one of the lowest LTV thresholds commonly offered by lenders, a 60% LTV will probably have some of the best and least expensive interest rates available. Additionally, you’ll need to borrow less money if you put down a 40% deposit rather than a lower one.
Is LTV the Same as Equity?
No, it is not. Equity is the estimated worth of a homeowner’s financial stake in their house. In other words, it is the property’s market worth as of the present day minus any liabilities that may be associated with it. Your lender uses your equity to calculate your loan-to-value ratio (LTV)
As more mortgage payments are made over time, and market forces affect the property’s present value, the home’s equity changes. Home equity can refer to more than just a mortgage loan that has been repaid. It is a lendable asset that homeowners can use to meet critical financial needs. Your financing options may increase as your equity level increases.
Conclusion
When determining whether to approve a borrower for a mortgage or a refinance loan, mortgage lenders take a number of factors into account, including the loan-to-value ratio. Lenders also take into account other things, such as credit scores. However, making a sizeable down payment and aiming for a low loan-to-value ratio is best if you want a cheap mortgage rate and to avoid paying PMI.
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