A key concept in helping home buyers assess how much they can borrow to finance their real property investment is the Loan – To – Value Ratio.
The Loan–To–Value Ratio (LTV for brevity) is the amount of the borrower’s loan divided by the appraised value of the property.
LTV = (Loan Amount) / (Appraised Value)
To illustrate, assume that Mr. Delos Reyes purchased a new house by the countryside worth PhP 3,000,000. He plans to borrow Php 2,400,000 from a local bank to finance his real estate investment.
Applying the concept, we get a Loan–To–Value Ratio of 80% for Mr. Delos Reyes.
LTV = (2,400,000) / (3,000,000)
LTV = 80%
Take note that in this example, we are assuming that the selling price is also the appraised value. In reality, banks will conduct their own appraisal of the property. The resulting Appraised value is used instead of the selling price, to divide the loan amount to finally determine the LTV ratio.
Equity and Loan-To-Value
Actually, the LTV ratio is the reverse of a borrower’s equity. Therefore, in our set example, since Mr. Delos Reyes has an 80% LTV ratio; he has equity of 20%.
By equity, we mean “how much a borrower owns in the value of his / her real property investment.”
So in Mr. Delos Reyes’s case, he only owns 20% of the value of his investment and owes 80% of it.
From the lender’s viewpoint, the higher equity you have tied up on your property, the less risky you are as a borrower.
A high loan-to-value ration also means that a home buyer owes more than he owns in the value of his investment. Therefore, banks will see the home buyer’s loan as one that is risky.
Low Down, High Loan-To-Value
Pag-IBIG Fund is a leading company in the Philippines that offers lower down payment and a high loan-to-value ratio, as high as 97.0% is some cases.
Other financial institutions are offering the same. But you will be required to pay for a private mortgage insurance to lessen the impact of the risk that they are placing on you as a borrower.
Financial Leverage and Loan-To-Value Ratio
Financial Leverage means the use of borrowed money to finance a real estate investment. From an investor’s viewpoint, the higher the leverage, the better because of the following reasons:
- Their risk is minimized
- More Cash available for other investments
The Importance of Loan-To-Value Ratio
Financial institutions generally look for three vital factors when qualifying you for a loan. These are:
- credit score
- debt-to-income ratio
- loan-to-value ratio
These factors are the benchmarks that helps the banks determine the following:
- the amount of loan to give you
- the interest rate of the loan
- the loan term
- whether the borrower is required to pay for a private mortgage insurance
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This article on Loan-To-Value ratio is written by Niel Kyro Jo.