An LTV ratio is used to evaluate the ratio amount between the loan amount, and the value of the underlying asset. A lender or creditor uses loan-to-value as a way to determine the cushion a borrower has between the underlying asset and the loan amount.
Take a look at the following example:
A company is looking to renovate a building and is seeking a loan worth $100,000. The creditor or financial institution performs diligence on the underlying asset (the building). Through the process of diligence, the creditor determines the LTV.
The building has been appraised at a value of $200,000, nearly 50% less than what the loan will be. Concluding, that the loan, if approved will have a 50% LTV.
With this example, you can see that the loan the company is seeking only represents 50% of the underlying asset.
The LTV ratio may differ across the spectrum, but many creditors will seek out an LTC ratio that is less than 80%. A smaller LTV ratio makes it easier for the borrower to repay, and meet financial agreements made with the creditor. Something to remember is that the lower a loan-to-value ratio is, the more secure the loan will be for both parties involved.
New home buyers will in most cases require a home loan to help with the purchase. In this regard, creditors or lenders will appraise the home to determine the LTV ratio. If the LTV ratio is considerably low, lenders will approve the loan.
If a home is appraised for less than what the buyers will purchase it for – lenders will consider the lower appraisal value, instead of the purchase price.
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