What is Loan-to-Value Ratio, How Banks Use it to Check Loan Eligibility?

The Loan-to-Value (LTV) ratio is the space between the size of loan you avail compared to the value of the collateral which secures the loan. This ratio is extensively used by banks and lenders to assess their risk in extending the loan or credit to you as a borrower. The main purpose of utilizing the LTV ratio for a creditor is the calculation that they do not approve a loan higher than the actual value of the collateral or property. If the LTV ratio increases, then the risk of the borrower’s default in repayment inclines as well.

Several financial institutions calculate the LTV ratio by using the given formula:

(Amount Borrowed/ Value of Property) x 100 = LTV Ratio Percentage

Why LTV Matters?

While the LTV ratio is not the only factor influencing in securing a loan or a line of credit or a mortgage loan, it plays an important role in determining how borrowing costs you. A high LTV ratio could possibly reduce the amount of loan extended by the bank or the interest rate could be much higher.

What are the RBI Guidelines on LTV Ratio?

As per the RBI guidelines on LTV ratio, the ratio in case of home loans of Rs.30 lakh or less can increase by up to 90% of the property value. This means you will have to pay a down payment of at least 10% and the remaining will be financed as loans. For loan amount between Rs.30 lakh and Rs.75 lakh, the LTV ratio can go up to 80% and for loans above Rs.75 lakh, the LTV ratio can go up to 75%.

The lower the LTV ratio, the lower the interest rates and terms. You can get to know your LTV ratio from your lender while availing a loan. With a low LTV ratio, you should negotiate for a lower interest rate, higher tenure, if required.

Combined Loan-to-Value Ratio

The meaning of Combined LTV (CLTV) ratio is the ratio of all secured loans on a property of the value of a property. Lenders use the CLTV ratio to check a prospective home buyer’s risk of any default when more than one loan is utilized.

Ways to Decrease Your Loan-to-Value Ratio

Now that we understand that a higher LTV ratio will lead to higher interest rate and terms by lenders, let’s find out ways to decrease your Loan-to-Value ratio so that you can have better negotiations with lenders.

  • The most obvious choice would be to increase the down payment, which will lead to a lower LTV ratio. However, you’ll have to wait for some saving corpus to pay that initial down payment.
  • If you don’t enjoy a savings corpus, then you’ll have to choose an unsecured loan to pay the down payment. That said, make sure the interest on the unsecured loan is not higher than the interest rate offered on the higher LTV ratio scenario.

 The Downside of LTV Ratio

The main disadvantage of a loan-to-value is that it includes the primary mortgage that the borrower owes and does not include other credit such as a second mortgage or a home equity loan. However, a CLTV is a more inclusive measure of the ability to pay by the borrower.

LTV ratios are essential for a borrower, but they’re part of bigger aspects which includes credit score, a good credit score helps you get higher LTV loans. Your monthly income which will pay your EMI and the asset that you’re planning to buy. Additionally, lenders will review your debt to income ratio to understand how affordable any fresh loan will be for the borrower to take on the additional monthly payments.

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