How do you calculate loan to value ratio?
Loan To Value Explained
I’m Corey Dutton and I’m a lender, today I’m going to talk to you about a term that is commonly used in lending, whether you’re a borrower or a lender. The term is “loan to value” or “LTV”.
What does Loan to Value mean?
You’re going to see that term a lot when you’re looking for a loan. And what does that mean? “Loan to Value” is simply the amount of the loan divided into the value of the property.
I’m also going to tell you why that’s important to the lender and to you in a minute. But let me go into an example super quick about how to calculate that.
How to calculate LTV?
I mean, how in the world do you calculate the loan to value ratio? Let’s just say that you are getting a loan for $50,000 USD. And what’s the value of the property?
Let’s say the value of the property is $100,000 USD. How are you going to calculate the loan to value or the “LTV”?
In this case, we’re going to take the $50,000 loan amount that we’re trying to get, and we’re going to divide it into the value of $100,000. And that’s going to give us: 0.50 or 50%. So, that’s a “50% loan to value” loan. When you you’ve got a loan amount of $50,000, and the value of the property is $100,000. Now why is that important?
Most of you are just shaking your head going, “So, now what?” What does that all mean to me as a borrower? And what does that mean to a lender?
What is a good loan to value ratio?
Well, let’s do another example super quick, 50% loan to value. You have no reference point. It’s hard to tell, is that good? Is that bad? Let me give you another example. Let’s say you’re taking a $90,000 loan against that $100,000 value property.
You’re going to divide $90,000 into $100,000, and that’s going to give you: 0.90 or 90% loan to value. So, you’ve got an LTV way down here at 50%, and you’ve got an LTV or loan to value way up here at 90%.
How does LTV affect interest rates?
Why is that important and why does it matter? Well, the lower the loan to value, the lower the cost of the loan, and why? Because the lower the loan to value, the lower the perceived risk of the loan by the lender. And on the other side, the 90% loan to value loan is a higher risk to the lender.
The higher the loan to value, the higher the risk to the lender. The lower the loan to value the lower the risk to the lender. And how does that translate to you as the borrower?
The lower the risk, the lower the cost of the loan or the interest rate.
The higher the risk, the higher the cost of the loan, and the higher the interest rate.