How is the loan-to-value (LTV) ratio calculated?

The loan-to-value (LTV) ratio is a crucial measure used by lenders to assess risk when extending a mortgage. It is determined by taking the loan amount and dividing it by the appraised value of the property. This ratio expresses the relationship between the amount of the loan and the value of the property and is typically expressed as a percentage.

Calculating LTV helps lenders evaluate how much equity the borrower has in the property, which can influence the terms of the loan, including interest rates and the requirement for private mortgage insurance (PMI). A higher LTV ratio indicates higher risk because it implies that the borrower has less equity in the property, making it more likely that the borrower may default on the loan.

For example, if a borrower takes out a loan of $250,000 for a home appraised at $500,000, the LTV ratio would be calculated as $250,000 divided by $500,000, resulting in a 50% LTV. This ratio would be viewed differently by lenders compared to a scenario where the loan amount is much closer to the appraised value, highlighting the importance of understanding how to compute LTV accurately.