One of the variables that mortgage lenders look at when considering you for mortgage pre-approval is your loan-to-value ratio, or LTV. Your loan to value ratio helps lenders understand how much of a home’s full value will be financed through the mortgage. Higher LTVs may be viewed as riskier loans. Not only does your LTV affect your chances of getting approved, but it can also impact the rates you are offered.
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What is LTV and how do you calculate it?
LTV measures the amount of a loan against the value of the thing it will purchase. An LTV can be used in any type of secured loan situation, but is most commonly used when talking about mortgages.
In the context of buying a new home, your LTV is the mortgage amount divided by the total value of the home. Let’s say you want to buy a home that costs $400,000. If you have a 20% down payment of $80,000, you’ll need a mortgage of $320,000.
The LTV is then determined by dividing the mortgage amount by the cost of the home. In this example, that’s $320,000 / $400,000, which equals 0.8 or 80% LTV.
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What is a good LTV ratio?
While you can technically get approved for a mortgage with an LTV ratio of 95%, aiming for an LTV ratio of 80% or less will increase your chances of getting approved for a mortgage with favourable interest rates.
You can lower your LTV by making a larger down payment, or by choosing a lower-priced home so your down payment accounts for a larger percentage of the purchase price. For ease, here’s how different down payments affect your LTV:
|Down Payment||LTV Ratio|
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Impact of high vs. low LTV
Lenders typically interpret a lower LTV as an indication of low risk, so an LTV of 80% or less may increase your chances of being approved, and may come with a lower interest rate. And lower interest rates often translate into smaller mortgage payments.
However, it is possible to be approved with a higher LTV, so don’t let that deter you from applying for a mortgage. Other factors also play into your level of risk, so a lender may still approve you for a mortgage with a high LTV. You just need to be prepared to pay mortgage insurance and follow the rules that come with having a high-LTV mortgage, such as a maximum amortization period of 25 years.
In fact, it’s not impossible for high-ratio mortgages to have lower interest rates than low-ratio mortgages. This might seem a little bit backwards, since we’ve said that higher risk requires higher rates. But, since people with a high-ratio mortgage have to pay mortgage insurance, lenders are protected against default, and are therefore more willing to offer lower rates for high-ratio mortgages than they would for low-ratio mortgages, which lacks mortgage insurance. Sometimes, even with the cost of mortgage insurance, the lower interest rate means you might come out ahead with a high-ratio mortgage.
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Why is LTV important?
LTV is important when buying a house because it helps lenders determine your risk to see whether or not they should pre-approve you for a mortgage. The lower your LTV, the better chance you have for being approved, as the lender is more likely to recover their losses should you default on your payments.
Your LTV also determines whether or not you’ll pay for mortgage insurance. In Canada, the maximum LTV for an uninsured mortgage is 80%, which means you will have a low-ratio mortgage. If your LTV is between 80% and 95%, then it’s considered a high-ratio mortgage and you will require mortgage insurance.
Finally, as a homeowner, your LTV will determine if you’re eligible for a home equity line of credit, or HELOC, or to refinance your mortgage. For HELOCs, the maximum of LTV will range from 65% to -80%. For refinancing, the maximum LTV is 80%.
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