A critical aspect of home lending is the loan-to-value calculation. This number is determined by dividing the loan principal that remains due by the present value of the mortgaged parcel. This is a vital factor whenever financial moves are under consideration.
Whenever borrowing is done in order to buy property, the loan-to-value number dictates the amount of funds necessary for a transaction to be possible. For instance, if the parcel is priced at $100,000 and lenders are willing to provide funds at an 80% loan-to-value ratio, $20,000 will be the needed down payment amount. Funds used for a down payment may be collected from accumulated savings, profits from selling a different property, loans from family, or possibly an additional mortgage.
Loan-to-value ratio is a phrase commonly used by mortgage loan underwriters and brokers. A typical description might be that a 90% loan equates to 8% interest with 2 points added on; a 95% loan is 8% interest plus 2.5 points. It will not take long to pick up this industry lingo.
After the loan has been secured and the transaction completed, the loan-to-value calculation serves as a measure of the equity the owner has in the parcel. Equity references the excess value that would exist if the home was sold and outstanding mortgages repaid. Therefore, being aware of existing equity permits a calculation of how much profit a sale would yield and then be available for a subsequent purchase. Further, equity is a measure of the amount of money that could be procured through a loan refinancing process. It is unlikely that all available equity could be borrowed, because loan underwriters prefer that some equity still exist untouched. For instance, a home worth $100,000 on which $60,000 was owed could produce $20,000 in cash (minus loan expenses) through an 80% loan-to-value refinancing loan.
Underwriters utilize the loan-to-value calculation to estimate the riskiness of a potential lending scenario. A greater loan-to-value ratio indicates a greater danger of default on the obligation. The reason for this is that a homeowner retaining more significant equity in the property has more resources invested and is therefore more likely to repay the loan. Also, an elevated loan-to-value number indicates that in the event of a foreclosure sale, the proceeds are unlikely to be sufficient to fulfill the outstanding loan amount.
Typical home loans are written for 80% of the property’s value. 95% mortgages were once common, but have become more difficult to find since the financial crisis. Mortgages at greater loan-to-value ratios may be available if they are guaranteed or are covered by insurance. Mortgage insurance is provided by private entities as well as the Federal Housing Administration (FHA), and qualified veterans have access to loans guaranteed by the Veterans Administration (VA). Home buyers will have to pay a greater amount of money to procure mortgage insurance.