What is Loan to Value and how is it calculated? It is one of the most important parameters to know before submitting a mortgage application.
![What is Loan to Value (LTV) on Mortgage, Meaning and Calculation](local/cache-gd2/9c/97f648e22c8a49c2eb8637371a325f.png?1739301413)
Loan to Value is a financial concept based on a real mathematical operation.
In detail, this expression indicates the ratio between the sum lent by a bank to the saver and the value of the property that the saver puts up as collateral. LTV is used by banks to decide whether to grant a loan to the applicant.
Its calculation is important in the case of request for a mortgage, since it relates the sum borrowed by borrowers and the value of the property. In a context in which mortgage rates are seen to decrease thanks to the ECB’s turnaround with rate cuts, knowing exactly what Loan to Value is helps to orient oneself.
If its value is high, the calculated risk on granting the mortgage increases and the costs that the bank requires from the customer are greater.
When the LTV is low, the risk on the mortgage is limited. Typically, a LTV above 80% is considered high, while a Loan to Value ratio below that is considered safer and normal.
Let’s look in detail at the meaning of Loan to Value, how to calculate it, and what can happen if it is too high.
What is Loan to Value? The meaning
Loan to Value (credit/value ratio means:
the financial parameter that results from the ratio between the amount requested as a loan and the value of the asset used as collateral for the loan.
All banks evaluate the Loan to Value to determine the level of risk assumed by granting a loan.
In essence, the value of the parameter is used by financial intermediaries to evaluate the risk associated with the provision of the mortgage. The higher the LTV, the greater the risk the bank can take.
When customers ask for a loan for an amount equal to or close to the appraised value of the property, and therefore there is a high Loan to Value ratio, banks perceive that there is a greater probability that the mortgage may default.
If the installments are not paid, the bank may have difficulty selling the house for enough to cover the outstanding mortgage balance and make a profit on the transaction.
How is Loan to Value calculated? An example
Loan to Value is a calculation: how is this parameter obtained, in practice?
The result is the amount of the mortgage (or loan/financing/) divided by the value of the property, expressed as a percentage.
For example, a saver who opens a mortgage of 70,000 euros to buy a house valued at 100,000 euros, the Loan to Value is equal to 0.7 or 70% (70,000/100,000).
In other words, the lender is covering 70% of the value of the property. The remaining 35% is covered by the capital of the person who requested the loan.
It can therefore be deduced that the credit/value ratio is a fundamental component in the underwriting of mortgages.
If the person who requested the loan/mortgage does not fulfill his obligations, the bank is aware that with the possible sale of the foreclosed property it obtains a sum that covers everything that was lent (70,000 euros repaid by the value of the house of 100,000 euros). It then has a safety margin of 35% on the value of the property. The higher the LTV, the less safety margin is obtained and the riskier the financing operation becomes.
The risk of a high Loan to Value and its role for the mortgage
Although the Loan to Value is not the only determining parameter for ensuring the disbursement of the mortgage, this indicator plays a fundamental role in determining the mortgage costs applied to the saver.
Most banks offer borrowers the lowest possible interest rate when the Loan to Value ratio is equal to or less than 80%.
A high LTV ratio does not exclude the possibility of taking out a mortgage, but in this case the costs increase significantly.
For example, a saver with a Loan to Value of 95% can manage to take out a mortgage, but the interest rate can be up to one percentage point higher than that of a borrower with a Loan to Value of 75%.
In addition to the higher interest rate, credit institutions must apply the obligation to open insurance for transactions that have an excessively high LTV ratio. The indications in this regard are from Bankitalia.
mortgage insurance substantially increases costs and, in a mathematical spiral, the higher the charges to be paid by the borrower, the greater the alert on a potential insolvency.
Precisely for this reason, knowing the Loan to Value before accessing a loan or mortgage is extremely important and can suggest what amount is really convenient to ask for financing.
Original article published on Money.it Italy. Original title: Cos’è il Loan to Value (LTV) sul mutuo, significato e calcolo