Four Things You Need To Know About Loan To Value Ratios and Home Equity Loans

[Feb 23, 2009.]

 

1. Defining Loan To Value Ratio
Whether you're considering a traditional refinance or a home equity loan, every homeowner should be familiar with the term "loan to value ratio". It's a very simple concept with a straightforward definition, but it is also one of the most crucial elements of the mortgage process.

A property's loan to value ratio is the ratio derived from one's total loan amounts divided by the property's appraised value. As an example, assume Mr. Jones has a 30 year fixed mortgage with a principal balance of $300,000 and a home equity loan with a balance of $100,000. If Mr. Jones' property appraised for $800,000, he would have a loan to value ratio of 50 percent.

2. Mortgage 101: It's All About the Home Equity
As mentioned, loan to value ratios play an integral role in the mortgage process whether one is looking to refinance or take out an additional home equity loan. Given the current housing economy, mortgage lenders are paying more attention to these ratios than ever before.  Aside from a borrower's income and credit standing, the loan to value ratio determines if an individual can qualify for a loan, how much he or she can borrow, and how much interest will be paid.

3. Less Equity Means More Risk -- For Everyone Involved
Mortgage lenders view higher loan to value ratios as risky and unstable. Unfortunately, this risk is passed onto homeowners as they will typically pay higher interest rates and have fewer financing options. In the case of a home equity line of credit for example, the absolute best one can hope for is to pay an interest rate at the Prime Rate--or even a few fractions below. However, with a high loan to value ratio, it is likely that a homeowner will pay a full percentage point or more above the Prime Rate. Unfortunately, some homeowners may not even qualify for a home equity loan if their loan to value ratio is too risky for the mortgage lender.

4. More Equity Means More Options
Owning a home with more equity translates into more options for the homeowner.  Currently, mortgage lenders prefer to see loan to value ratios well below 80 percent. A few years ago, mortgage lenders had no problem dealing with properties with ratios as high as 90 to 95 percent. But as lending standards tighten, so have the loan to value ratios standards. Homeowner's with an "acceptable" loan to value ratio will find it easier to refinance, obtain new home equity loans, and sell their home. During times of need, homeowners with strong loan to value ratios will also be able to safely rely on the equity built into their home.

 

About Author:

Renee Morgan has been a loan officer for over eighteen years. She is also a freelance writer and guest expert for radio and TV.