Key takeaways
- Loan-to-value ratio compares your loan amount to your home's value, with lenders offering better loan terms for a ratio of 80% or less.
- Government-backed loans allow higher ratios, making it easier for first-time buyers to put down smaller down payments.
- You can improve your ratio by making a larger down payment, choosing a lower-priced home or getting a strong appraisal before you apply.
A loan-to-value ratio is a number that compares what the home is worth to the loan amount you borrow to buy it. For first-time buyers, this ratio matters because it helps lenders decide whether you qualify for a loan and what programs you can use. Understanding your loan-to-value ratio can make it easier to plan for approval and find the right mortgage.
What is loan-to-value ratio?
Loan-to-value ratio, or LTV, is the loan amount divided by appraised value. The appraised value is what a professional says your home is worth, which may differ from the price you offer.
For example, if you want a $160,000 loan and the appraised value of the home is $200,000, your LTV is 80% ($160,000 ÷ $200,000 = 0.80, or 80%).
You can lower your LTV by making a larger down payment. If you put $120,000 down on the home and get an $80,000 loan, your LTV is 60% ($80,000 ÷ $200,000).
You can use a mortgage calculator to test different down payment amounts and see how they affect your ratio.
The ratio affects your loan approval, mortgage costs and insurance requirements
Lenders use your loan-to-value ratio to decide how risky it is to lend you money. If you can’t make the mortgage payments, a lender would be forced to foreclose on your home. The lender would try to pay foreclosure costs with your equity. But a large mortgage loan with a low down payment means there would be less equity, so lenders may have to use their own funds.
Most lenders see a ratio of 80% or lower as an acceptable risk. When your ratio is above 80%, you will likely need to pay for private mortgage insurance, or PMI, each month. This helps cover the costs of foreclosure should it be necessary.
PMI usually costs between 0.5% and 1% of the loan amount per year. For a $200,000 loan, that could mean an extra $80 to $165 per month. Once your ratio drops to 80% through regular payments or rising home value, you can usually request to cancel PMI.
First-time buyers often face stricter approval requirements when their LTV is high. Lenders may ask for a higher credit score, lower debt-to-income ratio or extra cash reserves. These added requirements can limit your loan options and make qualifying more difficult.
Related articles:
- What is a down payment on a home?
- What is private mortgage insurance?
- What credit score do you need to buy a house?
How does loan-to-value ratio impact first-time buyer programs?
Government-backed loan programs give first-time buyers more flexibility when it comes to LTV. Here is how each one works:
- Federal Housing Administration loans: Allow up to 96.5% LTV, meaning you can put down as little as 3.5%. But, if your LTV is above 90%, FHA requires you to pay a mortgage insurance premium for the life of the loan, even if it goes down over time to 80% or less.
- Department of Veterans Affairs loans: Available to eligible veterans and service members with up to 100% LTV, so no down payment is needed. There is no PMI, but a one-time funding fee applies.
- United States Department of Agriculture loans: Also allow up to 100% LTV for homes in eligible rural areas. Instead of PMI, you pay a fee.
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These programs make it possible to buy a home with a high LTV without the same costs that come with conventional loans. Knowing which program fits your situation can help you plan your budget and down payment.
Boost your loan-to-value ratio
Improving your loan-to-value ratio can help you qualify for better loan terms and avoid extra costs. Here are practical steps you can take:
- Save for a larger down payment. Even a small increase can lower your ratio and open up more loan options.
- Look at homes for sale priced below your maximum budget. With the same down payment, a lower-priced home means a lower ratio.
- Pay down existing debts to free up more savings for your down payment.
- Consider waiting to buy if you are close to reaching a better LTV threshold, such as moving from 95% to 90%.
- Get a pre-purchase appraisal or a comparative market analysis, which is a professional estimate of a home's value before you make an offer. This helps you avoid overpaying and keeps your LTV in check.
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Next steps
Ready to start your search? Use a mortgage calculator to test different down payment scenarios and see how they affect your ratio before you begin making offers.
Frequently asked questions
What happens to my loan-to-value ratio if the appraisal comes in lower than the purchase price?
Your ratio goes up because the appraised value is the denominator in the formula. If you offered $200,000 but the home appraises at $185,000, the lender uses $185,000 to calculate your ratio. That can push you into a higher LTV bracket, trigger private mortgage insurance or require a larger down payment to close the deal.
Does my loan-to-value ratio affect the interest rate I get?
Yes. Lenders typically offer lower interest rates to borrowers with lower ratios because they represent less risk. Even a small difference in LTV, such as 85% versus 79%, can mean a higher rate or additional pricing adjustments known as loan-level price adjustments.
Can I use a gift or grant toward my down payment to lower my ratio?
Most loan programs allow gift funds from family members or approved down payment assistance grants. Using gift money to increase your down payment directly lowers your ratio. Each program has its own rules about documentation and sourcing, so check with your lender before you apply.