Home loan borrowers frequently encounter several lender-imposed conditions, most of which are connected to the annual income required to be qualified for a home loan, the minimum down payment that must be raised by the borrower, and a decent credit score, and so on. Aside from that, the lender's maximum loan-to-value (LTV) ratio is a significant consideration in a home loan. Let's look at what a loan-to-value ratio is.
Did you know?
The RBI has published guidelines that allow house loan LTV ratios of up to 90% of the property value for loan amounts of less than ₹ 30lakh. The LTV ratio limit has been set at 80% for loan amounts beyond ₹ 30 lakh and up to ₹ 75 lakh, while the LTV ratio limit has been set to 75% for loan amounts above ₹ 75 lakh. If the LTV ratio is 90%, you'll have to pay at least 10% of the property's value out of pocket, with the rest of the money coming from a house loan. The Loan To Value ratio is used to determine how much of a down payment you'll need to make when buying a house or property.
Meaning of Loan To Value Ratio
The LTV full form is Loan To Value. The LTV ratio always refers to the percentage of a property's worth that a lender may finance with a loan. Financial institutions (banks, housing finance firms, non-banking finance companies) use this ratio to measure their risk in granting you a home loan.
The primary goal of employing the LTV ratio for a lender is to make sure that they don’t lend more than the property's true value. If a lender's LTV rises, the danger of a borrower default rises as well.
The LTV ratio is calculated by dividing the loan amount by the property's value, expressed as a percentage.
The LTV ratio formula is calculated by financial institutions as follows:
Borrowed amount/property value x 100 = LTV ratio
Assume Anamika is purchasing a home for ₹ 50 lakhs. An LTV ratio of 80% exists for a bank ready to give him ₹ 40 lakhs, whereas an LTV ratio of 90% exists for a bank willing to lend him ₹ 45 lakhs.
Home Loan Eligibility and LTV Ratio
Higher or Lower LTV? Which one is better? Read on to know what it truly signifies and clear your doubts.
If your LTV ratio is lower, your home loan eligibility will be higher. If your LTV ratio is low, you'll have a higher chance of securing better conditions on your home loan, including a lower interest rate. Your lender will tell you your LTV ratio when you apply for a home loan. If it is low, you can negotiate with the lender for cheaper interest rates, a longer payback period, and other benefits because the risk of lending to you is lower. Lower LTV ratios may result in lower home loan interest rates.
Under RBI standards, lenders must limit house loan eligibility to 75% to 90%. With these limits, the lender protects itself against a possible drop (correction) in property prices and a scenario where the borrower cannot repay the equal monthly instalment (EMI) on loan in the future.
Borrower’s Benefit from a Lower Loan-to-Value Ratio
The lower your LTV ratio, the better your home loan's other terms and interest rates will be. When you apply for a loan, the lender will tell you your LTV ratio. With a lower LTV ratio, you should be able to negotiate cheaper interest rates and a longer loan term with your lender (if required).
A home loan with a 60% LTV, for example, would be given at a reduced interest rate by the lender (require negotiation in case financial institutions do not offer a lower interest rate on a home loan). This is because the more personal funds utilised in the down payment for a home, the lower the lender's risk.
LTV vs Combined LTV
A loan-to-value ratio (LTV) compares the amount borrowed against a house to its value, whereas a combined LTV compares the total amount borrowed against the value of a house (across many loans). This is significant because, whereas many lenders only consider primary mortgages when calculating LTV, combined LTV considers all loans secured by the property, including first and second mortgages, home equity lines of credit, and home equity loans.
A Table on RBI Guidelines on LTV
Up to ₹30 Lakh
90% of the property value
Between ₹30 Lakh & ₹75 Lakh
80% of the property value
More than ₹75 Lakh
75% of the property value
In India, How Does Mortgage Investing Work?
Real estate investors who want to buy various properties, look for a mortgage loan, which is effectively a promissory note secured by the property they want to buy as collateral with the lender. Financial institutions sell mortgage notes to free up cash flow. Purchasing a mortgage note is a great way for people to invest in real estate without dealing with the difficulties of being a property owner.
How Does the Loan-To-Value Ratio Apply in Terms of Mortgage Investing?
The loan-to-value ratio compares the loan’s amount to the property's worth. It denotes the owner's stake in the property as a proportion of the total. When an investor buys a mortgage note, the LTV ratio is calculated by dividing the mortgage amount by the property value.
For instance, if the property is worth ₹100,000 and the loan secured against it is worth ₹60,000, the LTV ratio is 60%.
When the LTV ratio is high, the investor takes on more risk because the borrower has less equity in the property and is more likely to default on payments. If the borrower defaults, a mortgage note with a lower LTV is much safer because the note holder has a better chance of recouping their investment. An LTV ratio of 80% or greater is generally regarded as a high risk for investment, according to experts.
Loan-to-Value is a useful indicator for classifying debtors. Though it is not the sole criterion used to identify high-risk borrowers, it does suggest how dangerous a loan is and how motivated the borrower will be to repay it. It also decides how much the borrower will have to pay in interest. The loan will be more expensive if the loan to value ratio is higher.
The loan to value ratio is influenced by the following:
- The borrower's equity contribution
- The selling price
- The appraised value
If the appraised value is high, the denominator is large, resulting in a lower loan-to-value ratio. It can also be reduced by raising the borrower's equity participation and lowering the selling price.
Also Read: Accounting Ratios – Meaning, Types, Formulas
How to Reduce Your LTV?
In general, lowering your LTV on your loans, particularly mortgage loans, means lower total costs over the loan term. Because the LTV ratio is governed by only two variables—the loan amount and the asset value. Lowering the LTV ratio is quite simple:
- Make a larger or higher down payment: Saving for a substantial down payment may challenge your patience if you're ready to move into a house or car, but it'll be worth it.
- Concentrate your efforts on lower-cost targets: Buying a home that is a little older or smaller than your dream home or your plans may allow you to put more of your current savings toward the buying price.
Borrowing without understanding the loan to value ratio can have unfavourable long-term repercussions. An LTV ratio compares the amount of money you're willing to borrow to the value of the asset you wish to buy. If your profile is riskier and the asset to be mortgaged is older, the loan to value ratio will be lower. Khatabook can assist you with all of your business finance decisions. It will coherently clarify all your complicated issues.
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