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Loan To Value
The final part of the ‘triumvirate’ of eligibility is your loan-to-value (LTV) ratio. In the past, it was often fairly simple to receive 100% financing on a home, meaning you could purchase a home with little to no money out of your own pocket. Nowadays, this cannot be done. Most lenders are restricting borrowers to 90 to 95% maximum loan-to-value.
But what does that mean? For a purchase transaction, the loan to value is determined by the sales price of the house versus the appraised value of the house. For instance, if you need a $120,000 loan to purchase a home that appraises for $150,000, your LTV would be 80%, which is rather favorable, and you would likely be able to get financing for this with minimal scrutiny.
However, if you were attempting to purchase that same home, but rather than the seller asking for $120,000 for the home, he or she was asking for the full $150,000, you would find yourself in a pickle. The LTV for the transaction is now 100%. You would be required to furnish 5% to 10% of the money out of your own pocket in order to purchase the home… and be subject to the dreaded mortgage insurance!
Loan to value ratios become extremely important if you are attempting to refinance an existing property that you own. Since there is no ‘seller’ in this transaction, you cannot use a sales price to determine your LTV ratio. Instead, you need to compare the current value of the home versus the remaining balance on your first mortgage to determine if you can successfully refinance.
Take this scenario for example. You purchased a home five years ago for $150,000. You have paid promptly from day one, heck, you’ve even paid a little extra, and you have decided that you are not happy with your rate. You wish to refinance to lower your monthly payments. You have managed to pay off $25,000 of the mortgage in this time. You contact your mortgage loan consultant, and arrange for an appraisal of your home. The appraisal comes back and you find your home is now with $180,000. Your loan-to-value ratio would be 69%, making for an easy transaction.