Updated: Oct 22
Liz and Ellie have helped buyers in the Greater Boston area for decades. They’ve seen it all, from housing bubbles to busts, from no inventory to overflowing inventory. But one thing that doesn’t change is educating you on how the whole process works. Most home buyers will need a mortgage, and it’s vital to understand how mortgages work. Today we’re focusing on the loan-to-value ratio (LTV), which can profoundly affect a buyer’s finances.
What is the LTV ratio?
The LTV ratio is a measure comparing the amount of your mortgage with the appraised value or offer price of the property (whichever is lower). The lower your mortgage, the lower your LTV ratio.
Why does a buyer need to understand the LTV ratio?
Imagine finding the perfect home in a fast-moving market, and feeling the pressure to put together the best possible bid to win over the seller. You might want to bid way over the asking price in order to get that home. That may mean borrowing the highest amount you are pre-approved for. But first, take a breath (or two, or even ten), and know that your LTV ratio:
Impacts whether or not you qualify for a mortgage;
Determines if you must purchase private mortgage insurance (a LTV ratio above 80% requires PMI);
May lead to a loan not being approved if the LTV ratio is above 97.5%;
Affects the interest rate on your loan.
How can a buyer get a good LTV ratio?
At this point, it should be clear that a lower LTV is desirable for buyers. Here’s it is in a nutshell:
A greater down payment leads to a lower LTV ratio, which makes for a smoother, safer, more attractive transaction.
How exactly is the LTV ratio calculated?
A math degree is not required, luckily! There are plenty of free online tools, such as this one from nerdwallet, but a calculator or sheet of scrap paper will also do. Find the LTV ratio by dividing the loan amount by the lesser of either the offer price or the appraised value.
The appraised value of the home is needed to find the LTV ratio.
An appraisal is when a lender views the home being purchased and assigns a dollar value to the home, independent of the listing price or the amount of the offer. This is tricky, because normally the appraisal comes in after an offer has been accepted. The takeaway from this part: You can’t determine the exact LTV ratio before submitting an offer on your dream home. This means you need to have an honest conversation with yourself, your partner(s), and your lender about how to plan. An offer way above asking price may lead to a high LTV ratio, which can require PMI or even lead to the rejection of your loan application.
Here’s an example:
List Price $750,000
Offer Price $900,000
Mortgage Amount $720,000
If the property appraises at $900,000, the LTV is 80%. No PMI needed.
If the property appraises at $800,000, the LTV is 90%. The buyer must purchase PMI, but the loan will still go through.
If the property appraises at $735,000, the LTV is 97.96%. The loan will be declined in its current form. The borrower would have to put more money down to lower the LTV ratio and get approved.
Can a buyer still make an estimate of their LTV ratio before putting in an offer and getting an appraisal?
Absolutely, but it’s not guaranteed to work out perfectly. Liz and Ellie know the markets and they know the houses in the Greater Boston area, but they don’t control the appraisals and can’t predict what number any given appraiser will assign to any given home for sale. That being said, both Ellie and Liz work with our buyers to estimate the lowest conceivable number the appraisal could come in at. You can then multiply that figure by 80%, then subtract the resulting figure from the offer price. That is how much cash you may need to put down. From here, you can build the best offer possible and make your bid the safest one for the seller to accept. A savvy seller won’t just accept the highest offer; they’ll take an offer that’s profitable and most likely to close successfully.
What happens if the appraisal comes out below the offer price? What options are there to proceed?
This doesn’t happen all the time, but Liz and Ellie have seen it and learned from it. When a property appraises for less than the offer price, hence raising the LTV ratio, the buyer might:
Be able to back out of the deal;
Increase their down payment and rewrite the Purchase & Sale (P & S);
Pay a higher loan rate;
Pay for personal mortgage insurance (PMI);
Petition the lender to take another look based on properties they may not have included in the appraisal.
Which of these things happens depends heavily on the wording in the P & S, and on the attorneys’ negotiations. (Click here to learn more about the Purchase & Sale). When making an offer over the list price, buyers may insert an “appraisal contingency” at or near the original list price in the Purchase & Sale agreement. This will allow the buyer to back out of the deal if the home appraises much lower than expected.
The bottom line on the loan-to-value ratio:
The loan to value ratio is an important consideration when putting together an offer for a home.
Find the LTV ratio by dividing the amount of the loan by the lower of either the appraised value or the offer price. The answer is a percentage. 80% or below is ideal. If it’s higher than that, you may need to purchase Personal Mortgage Insurance or pay a higher rate. If the LTV is upward of 97%, your loan might be denied.
The appraisal number only comes in after the offer has been accepted. This means you must think through and plan for all possible appraisal outcomes when making an offer—Ellie and Liz can help with that!
Use your attorney to protect yourself in the Purchase & Sale agreement. Talk with them about which contingencies fit your needs.
An informed buyer is more likely to be successful. Ask your agent and your lender lots of questions.
Do you have any questions about the loan-to-value ratio, or are you ready to start the search for your new home? Contact us. We’re here to help.