All About Loan-to-Value Ratio

Secured loans are loans where you pledge an asset as collateral in exchange for borrowing money. For example, if you are applying for a home loan, the house acts as collateral for the lender in case of non-payment or defaults. But, how can lenders make sure that they do not sanction a loan amount that is more than the actual price of the property? This is where a Loan-to-Value (LTV) ratio comes into the picture. It is a calculation that shows how much risk a lender is taking on the amount sanctioned against the house.

In this article, we will go into the details of the LTV ratio, how it's calculated, and the factors that influence it.

Table of contents

• Definition of Loan-to-Value Ratio (LTV)
• How does Loan-to-Value ratio work?
• Importance of LTV in home loans
• Why LTV Ratio matters in lending?
• Factors influencing LTV ratio
• How to Calculate Loan-to-Value Ratio
• Impact of Loan-to-Value ratio on home loans
• Conclusion
• FAQs

Definition of Loan-to-Value Ratio (LTV)

The LTV ratio is a financial metric used by lenders to assess the risk associated with a secured loan. Expressed as a percentage, it is the ratio of the amount of money being borrowed to the market value of the asset to be purchased. An LTV ratio of 80% means that the lender is financing 80% of the appraised value of the asset, while the borrower is financing 20% of the value through a down payment.

LTV ratio plays a crucial role in determining loan eligibility and the interest rate offered by lenders.

How does Loan-to-Value ratio work?

The LTV ratio is an important metric for lenders because it indicates the level of risk they are taking on.

Higher loan amounts can lead to higher LTV ratios. A higher LTV ratio means the lender is financing a larger portion of the asset to be purchased, making it riskier for the lender if the borrower defaults. This can make loan approval more difficult and borrowers may have to pay higher interest rates.

On the other hand, a lower LTV ratio is considered less risky and borrowers have higher chances of loan approval with more favourable loan terms.

It is important to note that other factors like the borrower’s age, creditworthiness, income, and type of employment also play an important role in determining eligibility and interest rates.

Importance of LTV in home loans

Here are some reasons why LTV ratios are important for both lenders and borrowers when it comes to home loans:

• Risk assessment: A higher LTV ratio indicates a larger loan amount compared to the property value, making it riskier for the lender. In case of default, the lender might not recover the full loan amount by selling the property.
• Interest rates: Lower LTV ratios are generally associated with lower interest rates while higher LTV ratios may result in higher interest rates.
• Loan approval: Borrowers with lower LTV ratios are typically seen as less risky and may have an easier time obtaining loans with favourable terms.
• Down payment: A lower LTV ratio means that borrowers have to put down a larger down payment.

Why LTV Ratio matters in lending?

For lenders, the LTV ratio is a crucial factor in assessing the risk of the loan. Generally, the higher the LTV ratio, the less equity the borrower has in the asset such as a property. This means if the borrower defaults, the lender might not be able to recover the full loan amount through the sale of the property.

Conversely, a lower LTV ratio indicates that the borrower has more equity in the property, which can mitigate losses for the lender in case of default.

Lenders often have maximum LTV ratios that they’re willing to accept for different types of loans. For example, mortgages typically have lower LTV ratio limits compared to auto loans because houses are generally considered more stable assets than cars.

Factors influencing LTV ratio

• Down payment: A larger down payment results in a lower loan amount, which in turn decreases the LTV ratio.
• Property value: A higher property value results in a lower LTV ratio for the same loan amount, while a lower property value leads to a higher LTV ratio.
• Loan amount: A higher loan amount leads to a higher LTV ratio, and vice versa.
• The creditworthiness of borrower: Borrowers with stronger credit profiles and responsible repayment history may qualify for more favourable loan terms, including a higher LTV ratio.
• Property type: Residential properties may have different LTV limits compared to commercial properties. Even with the former, the type of property (such as single-family home vs condo) can affect the LTV ratio.

How to Calculate Loan-to-Value Ratio

The formula for calculating the Loan-to-Value ratio is:

Loan-to-Value Ratio = (Loan Amount / Property Value) x 100

Here’s a breakdown of the steps with an example:

Suppose you want to purchase a property valued at INR 50,00,000 (50 lakhs), and you have been approved for a loan of INR 35,00,000 (35 lakhs) to finance the purchase.

Using the formula, the Loan-to-Value ratio calculation would be:

Loan-to-Value Ratio = (35,00,000 / 50,00,000) * 100

= (0.70) * 100

= 70%

So, in this example, the LTV ratio is 70%. This means 70% of the property's value is being borrowed, and the borrower is required to provide the remaining 30% (INR 15,00,000) as a down payment.

Impact of Loan-to-Value ratio on home loans

A higher LTV ratio implies more risk for the lender as it indicates a smaller down payment and a larger loan amount. This can make it more difficult to get home loan approval, or borrowers may have to settle for higher interest rates. On the other hand, a higher LTV ratio means that borrowers have to pay a lower down payment, making homeownership more accessible.

Borrowers with a lower LTV ratio often benefit from more favourable loan terms, including lower interest rates, as they pose a lower risk to lenders. However, they have to pay a higher initial down payment.

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Conclusion

LTV ratio is a key metric for secured loans such as home loans as it affects both lenders and borrowers. It acts as a measure of risk for lenders and helps determine loan eligibility, interest rates, and down payment requirements for borrowers. A higher LTV ratio indicates higher risk for lenders, potentially leading to higher interest rates and stricter loan terms, while a lower LTV ratio implies lower risk and more favourable loan terms.

If you are planning to apply for a home loan, consider SMFG Grihashakti for a smooth online application process, swift loan processing, and attractive interest rates. We offer loan amounts of up to 90%* of the property’s value. For a quicker and hassle-free process, it is recommended to check home loan eligibility criteria and property document required for home loan in advance.