Loan to Value Considerations
What is the Loan to Value or LTV?
Loan to value, or LTV as it is commonly referred to, is the ratio of Loan Amount to the Value of a property. For example, a loan of $200,000 on a property valued at $400,000 is at an LTV of 50%. LTV considerations become important in several situations.
When a property is purchased, the down payment is critical to the lending decision. When the down payment is less than 20%, i.e. the LTV is greater than 80%, a lender will generally require mortgage insurance. This requirement also means that the loan will usually require an additional level of approval, from a Private Mortgage Insurance Company. Mortgage insurance coverage, or PMI, is a premium or fee which is included in the monthly mortgage payment. It can range from .22% to almost 1% of the loan amount annually, with the exact coverage determined by the loan type, insurance company, and LTV. Mortgage insurance payments are not tax deductible.
An alternative to obtaining PMI is to structure the purchase transaction to include a first and second mortgage, thus bypassing the need to have the additional mortgage insurance premium.
In a refinance transaction, the ratio of loan amount to appraised value is taken into account in a similar way. Especially when a borrower wants to obtain cash out in a transaction, the typical rule is a maximum of 75% of the appraised value for the total loan amount, including any cash out. There are lenders who will go beyond the 75% limitation, however the loan products and interest rates offered are generally not as competitive. Rate and term refinances, or borrowing the current loan amount plus applicable closing costs, can go up to 80% without requiring Mortgage Insurance. Again, at 80.01% or greater the new lender will demand mortgage insurance.
When combining a first and second mortgage in a refinance transaction, bear in mind that most lenders will require that the second loan be "seasoned" for a period of time, generally 12 months. If the second is not "seasoned" the lender will view the consolidation of the first and second mortgages as a cash out refinance loan, subject to the lower LTV guidelines.
Overall, the lower the ratio of the loan amount to the value appraised, the more favorably a lender views the risk of the loan. Loan to value considerations also will differ in owner occupant versus rental or non-owner situations.