Loan to Value Ratio and Its Importance

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Loan to Value Ratio

Are you going to make a big purchase? Looking for the most affordable lending options? Whether you apply for any type of loan or for a mortgage, potential lenders will generally assess multiple factors before they make their final decision. Your loan to value ratio is one of the most significant factors that define if your loan request will be approved or not. Learn what a loan to value ratio Canada means and why it is really important.

What Does Loan to Value Ratio Mean?

Let’s start from the very beginning and try to understand the definition of this financial term. A loan-to-value ratio determines the size of a personal loan you need to get to the value of a certain asset you are going to purchase. The amount of the loan should be divided by the value of the purchase in order to calculate this ratio. There are even personal loans for people with bad credit, of course, but the interest rates and loan terms can differ depending on various factors.

Finance-related service providers use the loan to value ratio formula in order to define the risks of a particular loan. The higher this ratio is, the riskier the loan is considered to be as the asset will be less likely to repay the loan. Using other words, your LTV ratio can also describe the borrower how much of an asset they really own in comparison to how much they owe to the lender.

How Do You Calculate Loan to Value Ratio?

Calculate Loan

We’ve already mentioned above what is a loan to value ratio, so here is how to calculate it and what is its formula. According to the 2018 Mortgage Survey Report from the New York City Rent Guidelines Board, the average maximum loan-to-value ratio fell to 73.5% in comparison with the 2017 report, when this ratio was 0.16% higher.

In order to define their LTV ratio, a borrower needs to divide the loan amount by the value of the asset or a house. For instance, if you are going to purchase a house worth $200,000 and you have to take out a personal loan of $150,000 to fund it. In your case, the value of the asset is $200,000 and the amount of the loan is $150,000. You can apply the above-mentioned formula and determine that your personal LTV ratio would be 75%. This figure is also one of the factors that define how long it will take to pay off the loan.

Why Loan to Value Ratio Is Important

The higher the borrower’s LTV is the riskier the loan is considered to be by the lenders. So, various lending institutions and finance-related service providers use a loan to value ratio to define how big of a personal loan the borrower needs comparing to what the house or the asset is really worth. In other words, the money you want to borrow relative to the asset value, the riskier this potential loan is in the eyes of the lenders.

What is a good loan to value ratio? It is probably the one where the borrower uses more of their own funds for a down payment to finance the asset, as it gives them more chances of getting approved for a personal loan due to lower risks. The majority of lending institutions are eager to deal with borrowers who have lower ratio so that the risks of not paying the debt in time are minimal.

Purchasing a House

buying a house

In the above-mentioned example of buying a house with 75% LTV, the borrower will have to make a 25% down payment. The other 75% of the total cost should be funded by the lender. Of course, some people may opt for the cheapest places to live in Canada where the value of the house for purchase would be much lower but in reality, it all comes down to one simple truth – you need to be a responsible borrower and have enough savings for a down payment.

Also, in case you are able to make a down payment that is less than 20% of the house cost, you will be accountable for purchasing mortgage default insurance. This insurance is aimed at protecting the lender. So be careful with your payments or you will also have to pay the insurance premiums in case of default.

All in all, the loan to value ratio is one of the most significant factors that can determine whether a borrower will be issued a personal loan and what loan terms and interest rates they will have to pay.

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