Applying for a mortgage means you’ll hear many terms thrown around. Among them are LTV, CLTV, and HCLTV. If you aren’t familiar with these terms, you should make yourself familiar. They impact your loan eligibility. They also affect your finances moving forward. Here we will define each term and explain how they affect your ability to get a loan.
The most basic term is the LTV. It stands for Loan to Value ratio. It’s the percentage of money borrowed compared to the value of the home. For example, if you borrow $150,000 on a $200,000 home, you’d have a 75% loan to value ratio. The more you borrow, the higher the ratio. You can figure the ratio out yourself with the following equation:
Loan amount/Purchase price = Loan to Value Ratio
The ratio directly affects your loan eligibility. Most loan programs have a maximum LTV they allow. The most common are as follows:
- Conventional – 97% in some cases, but most often 95%
- FHA – 97.5%
- USDA – 100%
- VA – 100%
As you can see, the USDA and VA loans don’t require any money down. You can borrow the full amount of the purchase price. In fact, you may even go slightly higher than 100% if you roll the funding fee into the loan. All other programs require some type of down payment, such as the FHA with a 3.5% down payment.
The conventional loan allows 3-5% down in most cases, but you’ll then pay Private Mortgage Insurance. Unless you put at least 20% down, you can expect this insurance to be a part of your mortgage payment.
The CLTV is the Combined Loan to Value ratio. This takes into consideration all loans on the property. For instance, if you have a 1st mortgage and a home equity loan, they both make up the CLTV. In order to figure out your CLTV, you’ll use the following formula:
First mortgage + second mortgage = Total mortgages
Total mortgages/Value of the property = CLTV
Generally, CLTV applies to situations where you are taking out a 2nd loan. Most home equity loans don’t allow a CLTV higher than 85% at the most. This leaves at least 15% equity in your home. Lenders use this threshold because holding a 2nd mortgage is riskier than holding a primary mortgage. This is because primary mortgages are paid first in the face of default. The first mortgage holder receives the full amount of what they are owed, if there’s enough money there. The leftover money goes to the 2nd lienholder. Oftentimes it isn’t enough to cover the full amount.
The HCLTV is similar to the CLTV because it takes into consideration the total loans on the property. It stands for High Combined Loan to Value. The difference between the two is this ratio considers the full available line amount. For instance, let’s say you take out a $100,000 home equity line of credit. You don’t necessarily use the entire amount though. Maybe you take out only $50,000. This means your true loan amount used for your CLTV is $150,000. In reality, though you have another $50,000 available to you. The lender must take that $50,000 into consideration.
The HCLTV lets a lender know the full amount you may borrow. Even if you haven’t borrowed them, you can. If the lender didn’t consider this, they could put themselves in a risky situation. If the value of your home fell and you defaulted, they could lose a significant amount of money.
This only applies to homes with a home equity line of credit attached to it. If you have a home equity loan, it’s a closed loan. You can’t change the amount you borrow. You receive the funds in one lump sum. With a HELOC, you can use the funds repeatedly. Even if you used the full amount of your credit line, you have the opportunity to use the funds again. This is when the HCLTV applies.
What’s the Magic LTV?
As we discussed above, every program has a different requirement. In general, though 80% is the magic number. When you borrow 80% or less, you don’t pay Private Mortgage Insurance. You also have a decent amount of equity in the home. This can help you in several ways:
- Motivates you to find a way to make your payments on time
- Gives you room to sell the home if you have trouble making payments
- Gives you leverage if the value of the home decreases
Of course, if you use a government-backed program, you don’t need an 80% LTV. However, the more money you put down, the better situation you put yourself in.
How a Low LTV Helps
A low LTV or CLTV helps you get better interest rates in many cases. Lenders look at many aspects of our loan, but the loan-to-value ratio is one of them. The more you borrow, the higher your risk. A higher risk usually means a higher interest rate. Lenders do this in order to make up for the risk. The less equity you have in the home, the higher your risk of default. If you want a lower rate, consider putting down a larger down payment.
Of course, lenders look at other aspects as well. They consider your credit score, debt ratio, and employment history. Lenders put each of the pieces of the puzzle together to come up with your interest rate. The lower your risk, the lower the rate a lender offers.
Shopping around for different lenders will probably yield the same results pertaining to your loan to value ratio. Each program has a specific requirement; there aren’t many ways around it. What may differ, however, is the interest rates. Some lenders charge higher rates for the higher LTVs. Shopping around may help you lower the rate a lender provides you.