The loan to value ratio (LTV ratio or just “LTV”) is a ratio that lenders use to assess relative risk of borrower’s potential default on a mortgage loan. The higher the LTV, the higher the risk for the lender because there is a higher loan balance compared to the home value. A loan with a LTV of greater 80% most often means that the lender will require private mortgage insurance or “PMI” on the loan. PMI is determined based on several variables including borrower’s credit rating, amount of loan and the LTV ratio. Higher LTV loans also means higher amounts of PMI charged each month.
Understanding the LTV Ratio
The first step is to calculate the LTV ratio is to know the current outstanding “L” or mortgage loan balance. Each month, the mortgage principal and interest are paid and the outstanding mortgage balance falls. This impacts the “L” portion of LTV causing a small decrease in LTV each month. Remember, this process does not consider other factors such as market appreciation, inflation and home improvements that can increase home value and allow for PMI cancellation much sooner.
It is also important to keep track of the “V” or home “value” portion of the LTV ratio. There are numerous methods to estimate a home’s value – starting with simple, automated market estimates to a full, in-person home appraisal from a real estate professional that lenders consider when cancelling PMI.
Over time, the loan is paid down enough to reach the 78% LTV ratio. The rules for The Homeowners Protection Act of 1998 requires automatic termination of mortgage insurance in certain cases for non-high-risk residential mortgage transactions when the loan-to-value on the home reaches 78%. For FHA -insured loans, the cancellation requirements are often more difficult.