LTV, standing for loan-to-value ratio, is a term used in finance and economy. It is defined as the ratio of the funds received as a loan, compared to the value of the real estate or other propety being purchased with the received funds. Because it is most commonly used by lenders (the side which finances the loan). In most cases, are banks and building societies and other, similar financial institutions. This ratio is used to show the ratio of the mortgage lien divided by the value or real property. The value of property is usually appraised by a certified appraiser.
If a buyer has to finance the purchase of a 100.000 $ house, and the funds he receives from the bank as a loan comprise to 90.000$, then the LTV ratio is 90$. As a result the rest of the funds, the remaining 10.000$ are the lender’s haircut. Which are covered by the buyer himself.
In general, the higher this ratio is, the more risk the lender has to handle. As said, the valuation of real property is usually performed by a certified appraiser. Who has to determine the market value of the property on the date of appraisal. His job is to determine the value of property, expressed in monetary units (price), as the value that can be achieved between two unconnected, well-informed parties, in an arms-lenght transaction, without fraud or coercion, on the date of valuation. The bank then accepts this valuation report and forms the loan height based on internal policy and the quality of the report.
LTV is one of the main risk factors when making the decision about a loan. The higher this ratio is, the greater the risk for the lender. Assessing the borrower and his credit history can be a very difficult task, because various other risks can be involved. Risk analysts have to consider low credit scores, late payments in previous loans, height of debt-to-income ratios, reserves and other elements. The lender has to take care of the fact how great is the likelihood of a default. And the fact that his funds are directly connected to the value of the secured real estate.
These are the key components of the risk analysis. The usual practice of a bank, or any other financial institution, for that matter, is to provide better terms for clients which provide better LTV ratio (lower interest rates, for example) and much stricter terms when the LTV ratio is higher.
The usual LTV ratio requested by financial institutions in the USA is less or equal to 80%. If this ratio is higher, usually private mortgage insurance is required by the lender. Some lenders even accept downpayments as low as 3% of the total value of the loan. Usually this is an exception of common practice, aimed towards first time buyers and low and moderate income buyers, war veterans and similar. With all said, LTV ratio is an important, probably a key factor in loan assessment, although never the only one.