Apart from affordable home loan schemes, homebuyers often come across several terminologies and criteria set by lenders, mainly related to the minimum down payment to be raised by the borrower, the annual income of the borrower to be eligible for a home loan, and a good credit score, to name a few. Besides this, lenders also set one important criterion, known as LTV, an acronym for Loan-to-Value ratio. If a homebuyer is eyeing a residential property and contemplating how much home loan he or she is eligible for, the lenders here will broadly analyse the Loan-to-Value ratio.
Hence, it becomes essential to understand what is a Loan-to-Value ratio? and why is it important for both lenders and borrowers?
What is a Loan-to-Value ratio ?
A Loan-to-Value ratio or LTV ratio is a metric set by the lender that measures the amount of debt used to buy a home and compares that amount to the value of the property being purchased by the borrower. Simply put, the LTV ratio is a financial ratio that compares the amount borrowed to the market value of the purchased asset. The market price of a property is the amount that would be paid for the asset on the open market between two unrelated parties, the borrower and the lender. A borrower is often surrounded by a dilemma of what a good Loan-to-value ratio is. The higher the Loan-to-Value ratio, the higher the risk for the lender and the lower the LTV ratio, the smaller the loan amount and the higher the down payment. To calculate the Loan-to-Value ratio, lenders divide the total loan amount or outstanding mortgage balance by the property’s current market value and convert it to a percentage. For example, if a housing property is appraised at INR 2 crores and the lender offers you INR 1.5 crore loan amount, the lender will divide INR 1.5 crore over INR 2 crore and multiply by 100 to get the LTV of 75%.
LTV = Loan Amount/Property Value*100
Loan-to-Value is an important metric that assesses the lending risk of the lender compared to the borrower’s requirement. The LTV ratio compares the size of the loan requested by the borrower against the size of the collateral being pledged while evaluating the borrower’s loan proposal. In case of any default by the borrower or foreclosure, a higher LTV percentage limits the chances of proceeds of sales to cover the outstanding principal amount and accrued interest rate on the property against loan type of loan. A lower LTV percentage is a saver if the lender has to foreclose on the loan. A Loan-to-Value ratio is important because it helps lenders determine a borrower’s capability for a home loan and rates. However, the importance of the LTV ratio varies from the perspective of buyers to the perspective of lenders.
To conclude, whether you are applying for a property loan or an auto loan, it is important to understand how the LTV ratio affects the overall borrowing cost, what a borrower can do to decrease the LTV ratio, and how doing so can save the borrower from saving money over the lifetime of the loan tenure.