A lender can use the loan-to-value (LTV) ratio to assess risk before approving a loan to a borrower. Given its importance, many people are left wondering: what is LTV? Understanding the ins and outs of how it works and its impact on loan terms can be greatly beneficial to investors. Here’s what you need to know about the LTV ratio, why it’s important, and how to calculate it.
LTV is a commonly used ratio that lenders use when evaluating the risks associated with a loan opportunity. LTV is the ratio between the loan amount and the value of the underlying asset. What is a Loan-to-Value ratio used for? Generally, LTV is used by lenders to evaluate how much collateral coverage their loan will have. Ultimately, risk is evaluated based on the likelihood that the proceeds from the sale of the collateral will be adequate to cover the outstanding principal loan balance if a lender has to sell the collateral to recoup the investment.
Calculating LTV is fairly simple. To calculate your LTV ratio, divide the loan amount by the total value of the underlying asset. This decimal number is then converted into a percentage. Note that the Asset Value can be based on an appraised value or value from another source.
For instance, if you intend to finance a borrower’s purchase of a property valued at $500,000, and your loan amount is $400,000 then you simply divide this loan amount ($400,000) by the property value ($500,000) and you have an LTV of 80.0%.
Many investors may first be introduced to the term LTV while in the market for a residential mortgage, but the ratio is used for loans with a variety of collateral-types. This means that the ideal LTV ratio is largely dependent upon the asset class and the collateral type associated with it.
Why is the LTV ratio Important?
When evaluating a loan opportunity, a lender uses the LTV ratio to, in part, determine the riskiness of a loan. When the loan amount is at or near the appraised value of an asset, the LTV is generally deemed high.
Lenders will typically charge a higher interest rate when assessing a high LTV situation because of the increased risk they are assuming. If a lender ever has to sell the asset to recoup their principal and interest, as in the case of default or foreclosure by the borrower, high LTV ratios carry an increased likelihood that the proceeds of the sale of collateral after an event of default may not be enough to cover the outstanding accrued interest and principal loan balance. A lower LTV provides a greater cushion for the lender in case the lender has to foreclose on the loan.
LTV is one of many tools Yieldstreet uses when evaluating a borrower’s loan proposal. Now that you read this explanation of what the LTV ratio is, you should be better able to understand our thought process when it comes to evaluating the investments we offer on our platform.
Still have additional questions or want to learn more about our investment opportunities? Reach out to us at [email protected].
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