What is LTV in real estate and how does it impact your mortgage?

Let’s say you want to buy a home for $200,000 and put $20,000 down. The remainder, $180,000, is your mortgage. To calculate the LTV ratio, you’d divide the mortgage by the value of the home, so the LTV formula would be: 

LTV = Mortgage amount / Appraised property value 

180,000 / 200,000 

That comes out to a high LTV of 90%. 

Now let’s say you put down $40,000 instead of $20,000. The remainder (your mortgage) comes to $160,000. So your LTV ratio would be: 

160,000 / 200,000 = 80% 

You’re likely to get a better interest rate if you put more money down, which would lower your mortgage, and in turn mean a lower LTV.

One note on purchase price versus market value: Since LTV is assessed using the appraised value of the property—i.e., the value the bank attaches to the property, not what you spend to buy it—your LTV won’t change if you underbid the seller and secure the property for a lower price. If a property is priced at $200,000 and the seller accepts your offer of $190,000, the figure used to calculate the LTV would still be the assessed value of $200,000.

For lenders, LTV indicates how risky offering a mortgage to certain borrowers can be. That’s because a higher LTV indicates less home equity, or a narrower delta between what you owe on your mortgage and the current appraised value of your home. If you were to sell your home, you’d still owe too much on your mortgage to cover what you spent.

For LTV ratios at 80% or lower, lenders will usually offer you a mortgage at the lowest interest rate possible. For LTV ratios above 80%, you may be offered a higher interest rate and you may be required to take out extra mortgage insurance. Again, LTV is a good reminder of why it pays to offer a higher down payment: A higher down payment means a lower mortgage.

Government lenders like Fannie Mae and Freddie Mac allow low-income home buyers to have an LTV up to 97% with mortgage insurance. Once your LTV reaches 80%—which it will as you pay off your loan and the house accrues value—you’ll no longer have to pay for mortgage insurance. 

Federal Housing Administration (FHA) loans allow for an LTV ratio of nearly the same—96.5%— but require mortgage insurance, even if your LTV drops to an acceptable rate. VA (Department of Veteran’s Affairs) and USDA (Department of Agriculture) loans, available to those who served in the military or live in remote areas, allow an LTV ratio up to 100%, meaning the borrower puts nothing down and obtains a loan equal to the value of the property.

Lenders treat investment properties differently than they treat primary residences. As a result, lenders typically have a lower maximum LTV for mortgages to cover investment properties. 

Banks also typically don’t allow cash gifts to cover the down payment for an investment property, nor do they make exceptions for first-time home buyers. Why? If you’re buying a primary residence, it’s a necessity, since that’s where you’ll live. If you’re buying a rental property, you should be willing to take on some risk since you’re investing in a property to make money.

Private mortgage insurance, or PMI, is what most banks require when your LTV is higher than 80%. It can add .5% to 1% to your annual mortgage costs and protects a lender from default. If you’re required to get PMI, you can opt to have it added in one lump sum to your closing costs or rolled into your mortgage. In most cases, except FDHA loans, when your mortgage balance dips and your LTV hits 80%, proving you’ve kept up your mortgage payments, you won’t have to continue paying for PMI.

Bungalow is the best way to invest and manage your real estate portfolio. We work with you to identify, purchase, fill, and manage residential properties—so that you can enjoy up to 20% more in rental income with a lot less stress. Learn more about Bungalow.