Looking for a home loan? When looking for a secured loan a term commonly thrown around is the “Loan-to-Value” ratio. Knowing about this term is in every borrower’s interest as it affects pricing and eligibility for loans.
“LTV” is a lending risk assessment ratio that credit institutions examine before approving a loan such as home loan, car loan, loan against property, loan against shares, MFs or FDs, etc. It is an important barometer that lenders use to gauge the risk they would be exposed to. Therefore, if the LTV is high a higher rate will be charged whereas if the LTV is low a lower interest rate will effectuated.
For fresh mortgages, it means the borrower will be paying a down payment of 25% of the property value or 50 lakhs from own pocket. For loans against an asset, this means 75% of property is hypothecated with the lender and only 25% of ownership is retained by the borrower. You can see now that LTV is an important figure for a lender because it reveals how much skin each party has in the game.
What Does A High LTV Mean?
By the principles of simple arithmetic, a high LTV means a higher loan amount. That means a higher exposure of the borrowed funds, which essentially culminates into a greater risk taken by the lender and therefore a higher rate of interest. Interest rates are a function of risk and are directly proportional to it. A higher interest rate means a higher EMI and higher debt burden on the borrower.
A high LTV is certainly not the only factor that decides the eligibility and the interest to be charged to the borrower but it is a very crucial metric that indicates the level of exposure of a lender.
Credit institutions have different underwriting policies and they have distinct LTV thresholds. The maximum permissible LTV is determined by an institution’s internal underwriting policy, type of collateral and factors that depreciate the value of an asset. For example, a car will depreciate in value faster than a home. Infact some assets such as shares, gold or MFs may appreciate in value during the tenure of the loan. Therefore, LTV that would be allowed varies from loan to loan and bank to bank.
On the other hand, having a lower LTV will mean you have a greater percentage of ownership; you will fall in a less risky classification of borrowers by banks and shall enjoy lower interest rate.
A higher LTV, let’s say of 95% or may be 100%, does not mean you will not be approved for a loan. But it will mean that you will have to bear a higher rate of interest. The Property Loan -to-value ratio is an important component for lenders. All credit institutions assess the LTV in an effort to determine the risk they are exposed to.
Any borrower seeking a higher percentage of loans, against the appraised value of the property, or having a higher LTV, is perceived to be risky because there is little or no equity stake of the borrower in the asset. For such loans the probability of default is high as the borrower has taken an amount nearly equivalent to the entire value of the property. It would be as good as the property is sold to the lender. Should there be a foreclosure, the lender would find it difficult to sell the house and recover their losses, let alone make a profit. Mostly lenders stay far from the idea of lending to the entire value of the property.