Loan-to-Value Ratio (LTV): What Is It and Why It Matters
By Michelle Clardie on 04/04/2024.
Reviewed by Josefin Gatsby
The loan-to-value (LTV) ratio is one of the most important metrics in real estate investing. It can help you assess your investment portfolio risk and help you make smart decisions regarding asset financing.
In this article, we’ll break down LTV ratios. You’ll learn:
What LTV is,
Why LTVs matter,
How LTVs are calculated, and
How LTVs compare to LTCs.
Here’s your guide to LTVs.
What is a Loan-to-Value Ratio?
A loan-to-value ratio is the amount of an asset that is financed, as a percentage of the value of the asset.
As an example, let’s say you have an investment property with an LTV of 80%. This means 80% of the property’s value is financed, and 20% of the property is owned equity.
Why Does the LTV Matter?
The LTV matters both as an indicator of portfolio risk and as a factor in determining terms for new potential loans.
LTV as a Risk Indicator
A higher LTV ratio indicates a higher level of risk because more of the property is financed than is owned outright. A lower LTV indicates a lower level of risk because the owner has more equity in the property.
The risk levels apply to both property owners and lenders.
A high LTV presents a higher risk for the property owner because their equity is limited to a smaller share of the property's value. If, for example, you have an LTV of 95% on your home due to special financing (like an FHA loan), and a market disruption causes property values to dip by 6%, you would owe more on the home than the home is worth. This is called being “underwater” on your mortgage. As of Q4 2023, around one million homeowners were underwater on their mortgages. This sounds like a lot, but it is far fewer than the figures we saw during the housing market collapse of 2008 when an estimated 12 million homeowners were underwater.
The vast majority of homeowners who go underwater do so because their LTV is too high. As long as the owners continue to make payments through the dip, they will eventually come back to positive equity. But being underwater is an uncomfortable position, however temporary.
This same situation puts lenders in a risky position. Most mortgage lenders prefer predictable interest payments; they have no interest in acquiring properties through foreclosure. Higher LTVs can increase the likelihood of foreclosure, which would leave lenders with properties to sell off, perhaps at a loss.
LTV as a Factor for Loan Terms
Because high LTVs pose a risk to lenders, lenders have LTV maximums. While lenders are typically free to set their own rules, here are some general rules of thumb for LTV limits by mortgage loan type:
Conventional loans. With exceptional credit, homebuyers may be able to secure a conventional loan with an LTV as high as 97%. The limit is typically much lower for homes that are not a primary residence (ie. investment properties and second homes). For investment properties, lenders often set the LTV ratio at around 80%.
FHA loans. FHA loans are backed by the Federal Housing Administration, so lenders are willing to offer LTVs of up to 96.5% with good credit. FHA loans are for primary residences only. However, savvy investors have used FHA loans to purchase multi-family properties with up to four units. They live in one unit and rent out the others in a classic house hacking strategy.
VA loans. VA loans are backed by the US Department of Veteran Affairs and are reserved for active military service members, veterans, and their spouses. VA loans carry a 100% LTV, making this a true “0% down payment” option. As with FHA loans, VA loans are for primary residences, but buyers can purchase a multi-family home with up to four units using VA funding, so long as the buyer lives in one of the units.
Mortgage Refinancing. Many investors will refinance one property to pull cash out of the deal so they can finance another property. Lenders typically require that the LTV remain between 70 and 80% following the refinance.
It is important to note that buyers are often required to pay a form of private mortgage insurance (PMI) for loans with an LTV over 80%. This insurance helps protect the lender in case of default. PMI premiums can easily cost hundreds of dollars per month, which is one of the reasons it’s often advisable to keep the LTV at or below 80%.
Additionally, lenders often reserve their most favorable interest rates for buyers who put down a deposit of at least 20%, which would also equate to an 80% LTV ratio.
How is LTV Calculated?
LTV is calculated by dividing the loan amount by the value of the property.
For example, if you have a $500,000 mortgage on a property valued at $800,000, your LTV is 62.5% (500,000 divided by 800,000).
To make sure your LTV is accurate, it’s best to use a recent appraised value from a formal appraisal.
What is a Good LTV?
For most real estate investors, there is a sweet spot where debt is being appropriately leveraged without becoming too risky. Many investors find this balance in the 60-80% range.
Carrying an LTV over 80% may feel too risky for many investors. Not only do they not have enough equity to qualify for the most favorable interest rates, but they might also be concerned about going underwater on the mortgage if the market suddenly drops for any reason.
On the other hand, carrying an LTV under 60% may feel inefficient. Leveraging debt is an important part of real estate investing. It allows you to use other people’s money to build a real estate portfolio. Keeping too much of your capital tied up in one asset means you’re not using that capital to pursue additional investments and grow your portfolio.
Loan-to-Value vs. Loan-to-Cost
Loan-to-cost (LTC) is similar to LTV, but in LTC, you’re comparing the loan amount to the cost of the asset instead of the appraised value of the asset.
So, to calculate the LTC, you would divide the loan amount by the cost of the asset.
For example, if you have a multi-family development project that will cost one million to build, and the completed project appraises at $1.75 million, the LTC would be 57% (1,000,000 divided by 1,750,000).
When to Use LTV and When to Use LTC
While both LTV and LTC can be used for any financed investment, it’s generally best to use LTV when buying a new property with minimal required renovation and LTC when dealing with heavy construction/renovation.
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