Explained: Everything You Need to Know About Loan-to-Value

Buying a new home has always been a goal we all strive to achieve. With the rapid escalation of real estate prices, home loans have become one of the popular ways to attain such goals.

One of the first things a person looking for a new home will want to know is how much financing they can get for it. Loan-to-value ratio lets the borrower know the maximum loan amount they can get against a property. Here are some basic details of the LTV ratio.

What is a loan-to-value ratio?

Loan-to-value or LTV ratio is a financial metric used by banks and NBFCs to grant a loan based on the collateral value and the risks associated with an applicant. In other words, the loan-to-value ratio denotes the percentage of a property value that a borrower will receive as a loan. The property value is determined by the lender after getting it assessed by a professional valuation team.

A high LTV ratio signifies higher risk from a lender’s perspective while a low LTV ratio signifies a lower interest rate along with better terms. Usually, financial institutions use this metric to ensure that they don’t end up lending more money than the actual value of the property. 

Suppose, a lender offers a loan-to-value ratio of 70% for a car. This means that the lender will provide a loan of up to Rs.7 lakh if this car costs Rs.10 lakh.

How to calculate the LTV ratio?

LTV ratio is calculated by dividing the loan amount by the value of an appraised property. To simplify, appraised property value is the property value assessed by a lender’s valuation team.

The LTV ratio calculation formula is given below:

Borrowed amount/appraised value of property x 100 = LTV ratio

Let’s say Mr Kunath wants to buy a home worth Rs. 1 crore which is the market value. However, Mr Kunath’s lender informs him that they can only grant a loan of 75% of the total market value. 

Therefore, this lender can approve only up to Rs.75 lakh and the remaining Rs.25 lakh has to be paid by him. In such a scenario the loan-to-value ratio is 75% while the remaining 25% has to be paid by Mr Kunath as a down payment.

One can also consider using an LTV ratio calculator if this type of manual calculation seems confusing and tedious.

Significance of high LTV for borrowers

Banks and NBFCs usually calculate the loan-to-value ratio in order to analyse the risk associated with granting a loan. The higher the LTV ratio, the higher the risk for a lender. This might make things more difficult for the borrowers to get that loan approved.

In case the lender approves the loan, it is quite common that they will charge a higher rate of interest. One may also avail a higher LTV ratio on a loan against property or a home loan if his/her credit score is high.

Ways to improve the LTV ratio

While getting a loan against property, borrowers should ideally aim to reduce the loan-to-value ratio by making larger down payments. By lowering the loan-to-value ratio, one may reduce the overall cost of his/her loan. Listed below are the ways to improve this ratio for a loan based on the borrower’s requirements:

• Make larger down payments: One must consider saving and investing more money to make larger down payments. By being patient and investing regularly, one can accumulate sufficient funds for bigger down payments. A larger down payment reduces one’s overall debt, resulting in a lower cost of the loan.
• Improve credit score: A good credit score can also help in availing a higher LTV ratio. A credit score of 750 or above shows the credibility and financial stability of a borrower. Hence, applicants should improve their credit scores by paying their bills on time.
• Adding a co-applicant: A co-applicant or co-borrower with a stable source of income can help to increase one’s loan eligibility. This helps to improve the loan-to-value ratio for a loan. To get the desired loan amount, applicants can consider adding a co-applicant.
• Focus on lower cost targets: Sometimes, sacrificing a bit of one’s dream home can lead to bigger dreams in the long run. Choosing a slightly smaller or older home can result in a lower amount of debt and a smaller loan principal, which ultimately reduces the cost of one’s loan.

What is an ideal LTV ratio?

The loan-to-value ratio typically varies from one lender to another. However, most experts have observed that on average an LTV ratio below 80% is said to be a decent ratio. At the same time, this does not indicate that any loan application with an LTV ratio above 80% will get rejected. But if in case the LTV is above 80%, there is a high possibility that the lender will charge a high rate of interest.

Therefore, while planning for any such loans, one must always keep in mind that the lower the loan-to-value ratio, the lower the cost of a loan. However, if one wishes to avail a higher-value loan for an expensive property, he/she should have a good credit score and sufficient income.

Several banks or NBFCs offer pre-approved loans on different types of loans such as home loans, personal loans, and car loans to their existing customers. These offers help applicants know their loan eligibility beforehand and quickly apply for the loan. To check out the eligibility, individuals can visit the lender’s website or app, or they can contact their relationship manager.

To conclude, the loan-to-value ratio is the percentage of a property value which a lender can grant as a loan. A lower LTV ratio can result in more favourable loan terms as it indicates a lower risk for the lender. On the other hand, if the borrower’s financial background qualifies for a big loan amount, they can avail a higher LTV ratio. 

But one needs to find a lender willing to provide a high-value loan to borrowers with high credit scores. Hence, it’s a good idea to conduct thorough research and plan in advance.