LTV (Loan-to-Value Ratio)

The Loan-to-Value (LTV) ratio is a financial term lenders use to show the size of a loan compared to the value of the asset being financed, such as a house or a car (including used car loans). It’s typically expressed as a percentage.

Key Concepts

• Compares Loan to Asset Value: Think of the asset’s value as the whole pie. The LTV ratio tells you what slice of that pie is being financed by the lender, and what slice you, the borrower, are covering with your own funds (your down payment or existing equity). A high LTV means a bigger slice is being financed, and a smaller slice is yours upfront. Conversely, a low LTV means you own a larger portion of the pie from the beginning. This initial ownership stake is crucial for both the lender and you.

• Calculation Breakdown: The formula LTV=(Asset Value/Loan Amount​)×100 is straightforward but powerful.

  • The Loan Amount is the total sum of money you are borrowing from the lender.
  • The Asset Value is the appraised value or the market value of the item you are purchasing. For a house, this is typically the appraised value determined by a professional. For a car, it might be the dealer’s selling price or a valuation guide’s estimate.
  • Multiplying by 100 simply converts the decimal result into a percentage, making it easier to understand and compare.

  Consider buying a property valued at PHP 5,000,000 and taking out a loan of PHP 4,000,000. The LTV would be (4,000,000 / 5,000,000) * 100 = 80%. This means 80% of the property’s value is being financed.

• Lender’s Risk Assessment – The Higher the LTV, the Higher the Risk: From a lender’s perspective, a high LTV loan presents a greater risk for several reasons:

  • Lower Borrower Equity: With less of their own money invested, borrowers with high LTV loans might be more likely to default if they face financial difficulties. They have less to lose.
  • Smaller Buffer Against Depreciation: If the asset’s value declines (which can happen with cars immediately after purchase, or with property during market downturns), a high LTV loan means the outstanding loan balance could quickly become higher than the asset’s worth. This is known as being “underwater” or having “negative equity,” making it harder for the lender to recover their funds if they have to foreclose or repossess.
  • Increased Loss in Case of Default: If a borrower defaults on a high LTV loan, the lender might incur a larger loss when selling the repossessed asset because a smaller portion of the original loan amount was covered by the borrower’s initial investment.

  Because of this increased risk, lenders typically charge higher interest rates or require additional security (like private mortgage insurance in the case of high LTV home loans) for loans with higher LTV ratios.

• Borrower’s Equity – Your Stake in the Asset: Your equity is essentially the portion of the asset you truly “own” free and clear.

  • Calculation: Equity = Asset Value – Loan Amount. Using the previous example, your initial equity would be PHP 5,000,000 – PHP 4,000,000 = PHP 1,000,000, or 20% of the property’s value (which is 100% – 80% LTV).
  • Benefits of Higher Equity (Lower LTV): For you, a lower LTV (and thus higher equity) has several advantages:
    • Lower Monthly Payments: A smaller loan amount generally translates to lower monthly repayments.
    • Better Interest Rates: Lenders often offer more favourable interest rates on loans with lower LTVs because they perceive them as less risky.
    • Faster Equity Building: With a larger initial stake, you build equity in the asset more quickly as you make loan payments and as the asset potentially appreciates in value.
    • Greater Financial Flexibility: Having more equity can provide a financial cushion and more options in the future, such as easier refinancing or the ability to borrow against your equity.

Why is LTV Important? (Impact on Borrowers and Lenders)

The Loan-to-Value (LTV) ratio carries significant weight for both those seeking to borrow money and the financial institutions providing the loans:

• Loan Approval: The LTV ratio is a critical factor in a lender’s decision to approve your loan application. A higher LTV signifies a greater risk for the lender, which may lead to stricter qualification requirements. You might need a better credit score, a more stable income, or a larger amount of collateral. In some cases, a very high LTV could even result in the denial of your loan application if the lender deems the risk too substantial. Conversely, a lower LTV demonstrates a lower risk and increases your chances of loan approval.

• Interest Rates: The LTV ratio directly influences the interest rate you’ll be offered on a loan. Loans with higher LTVs are generally associated with higher interest rates. This is because the lender is taking on more risk and charges a higher premium to compensate for that increased potential for loss. On the other hand, if you have a lower LTV, lenders often reward this lower risk with more favourable (lower) interest rates, saving you money over the life of the loan.

• Private Mortgage Insurance (PMI) / Lender’s Mortgage Insurance (LMI): This is particularly relevant in the context of real estate. If your LTV exceeds a certain threshold (commonly 80% in many countries, including Australia), lenders often require you to pay for Lender’s Mortgage Insurance (LMI) in Australia (or Private Mortgage Insurance (PMI) in the US). This insurance policy protects the lender if you default on the loan. The cost of LMI can be significant and is an additional expense for borrowers with high LTVs. By having a lower LTV (i.e., a larger down payment), you can often avoid the need to pay for LMI, resulting in considerable savings.

• Loan Terms: Beyond interest rates, the LTV can also affect other loan terms and conditions. For instance, lenders might offer more flexible repayment options or be willing to negotiate other aspects of the loan agreement for borrowers with lower LTVs, as they are seen as less likely to default.

• Equity Building: For borrowers, the LTV directly relates to how quickly they build equity in the asset. A lower LTV means you have a larger initial stake in the asset. As you make loan payments, a greater portion goes towards building your ownership (equity) because less of the asset’s value is financed. This provides a stronger financial foundation and more security for the borrower.

Examples of LTV in Different Contexts:

• Mortgages (Real Estate):

  • A home in Australia valued at AUD $500,000 with a mortgage of AUD $400,000 has an LTV of (400,000 / 500,000) * 100 = 80%.
  • A lower LTV (e.g., 70% or less), meaning a larger down payment (at least 30% of the property’s value), is generally viewed as less risky by Australian lenders. This can lead to better loan terms and potentially avoid the requirement for LMI.

• Car Loans:

  • A car purchased in Australia for AUD $30,000 with a loan of AUD $25,000 has an LTV of (25,000 / 30,000) * 100 = approximately 83.3%.
  • Lenders providing car loans in Australia also use the LTV to assess the risk associated with financing the vehicle. A higher down payment from the borrower results in a lower LTV, which can increase the chances of loan approval and potentially lead to more favourable interest rates. Borrowing a very high percentage of the car’s value (a high LTV) might result in higher interest rates or stricter loan conditions.