Become a Financial Modeling & Valuation Analyst (FMVA)®. Enroll today to advance your career!
Login to your new FMVA dashboard today!

Loan-to-Value Ratio

A financial ratio that compares the size of a loan to the value of an asset that is purchased using the proceeds of the loan

What is the Loan-to-Value Ratio?

The loan-to-value (LTV) ratio is a financial ratio that compares the size of a loan to the value of an asset that is purchased using the proceeds of the loan. The LTV ratio is an important metric that assesses the lending risk that a lender carries by providing the loan to a borrower.

 

Loan-to-Value Ratio

 

The value of an asset is generally determined either by independent appraisers or the most recent purchase price of an asset. Commonly, when both values are known, a lender will choose the lesser of the two values.

 

Importance of the Loan-to-Value Ratio

Generally, a high LTV ratio indicates a high level of lending risk. The rationale behind it is that the purchased property (e.g., house) in the mortgage is used as collateral. Thus, the LTV ratio essentially compares the size of the loan requested to the size of the pledged collateral.

Due to the abovementioned reason, the assessment of the LTV ratio serves a crucial role in mortgage underwriting. For example, conventional mortgage lenders usually provide good loan terms if the LTV ratio is less than 80%.

For applicants whose LTV ratio exceeds 80% but still below 100%, loans can still be provided if the applicant possesses a strong credit history. However, the loan terms will likely include higher interest rates and will require the purchase of the private mortgage insurance (PMI). Loans with the LTV ratio above 100% is likely to be rejected.

 

Formula for the Loan-to-Value Ratio

The general formula for calculating the loan-to-value ratio is:

 

Loan-to-Value Ratio - Formula

 

Example of Loan-to-Value Ratio

Sam is applying for a mortgage from a bank to buy a new house. He needs to borrow $500,000. However, the bank wants to assess the risks associated with the loan by calculating the loan-to-value ratio.

An independent appraiser’s determined that the current value of the house that Sam wants to purchase is $700,000. Therefore, the loan-to-value ratio of the mortgage is:

 

Loan-to-Value Ratio - Sample Calculation

 

The loan-to-value ratio of 71% is generally considered to carry a relatively low risk to the lender. Thus, the bank is likely to approve Sam’s mortgage application.

 

More Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

  • Cost of Debt
  • Debt Schedule
  • Leverage Ratios
  • Loan Covenant

Financial Analyst Training

Get world-class financial training with CFI’s online certified financial analyst training program!

Gain the confidence you need to move up the ladder in a high powered corporate finance career path.

 

Learn financial modeling and valuation in Excel the easy way, with step-by-step training.