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- Your loan-to-value ratio is the correlation between the amount you owe on your mortgage and the value of your home.
- For example, if your LTV ratio is 80%, you own 20% of your home, financially speaking.
- Most lenders want your LTV ratio to be 80% or less when you refinance, but you may be approved with a higher ratio if other parts of your financial profile are strong.
- Your LTV ratio will affect other parts of the refinancing process, too, including your interest rate and private mortgage insurance.
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A loan-to-value ratio sounds like confusing mortgage jargon. But it’s pretty much what it sounds like — the relationship between the amount you owe on your mortgage (the loan) and how much your home is worth (the value).
Knowing your LTV ratio helps you understand how much of your home you own in financial terms. Subtract your LTV ratio from 100 to reveal your home equity. If your LTV ratio is 75%, for example, you own 25% of your home.
The lower your LTV ratio, the better. A lower ratio means you have more equity in your home and are closer to owning it outright.
Your refinance application is more likely to be approved if your LTV ratio is low, because lending to someone with a low ratio is less risky for lenders. A better LTV ratio can also land you better terms on your refinanced mortgage.
To figure out what your LTV ratio is, divide the amount you owe on your mortgage by the value of your home, then multiply by 100.
Let’s say an appraiser looks at your home and tells you the current value is $300,000. You’ve already paid down part of your mortgage, but you still owe $250,000.
Divide $250,000 by $300,000, and you’ll get 0.833. Multiply that by 100 to get 83.3. Your LTV is 83.3%, and your home equity is 17.7%.
The rule of thumb is that your LTV ratio should be 80% or lower to refinance. This means you have at least 20% equity in your home.
You may be able to refinance with a higher ratio, though, especially if you have a very good credit score. But if you’re refinancing into a conventional mortgage with a higher LTV ratio, you’ll still have to pay for private mortgage insurance. Your lender will also probably charge you a higher interest rate.
LTV ratio requirements are more lenient when you refinance into a government-backed mortgage, including an FHA, VA, or USDA loan. Your ratio can be as high as 96.5% for an FHA mortgage, and you could refinance with no equity in your home with a VA or USDA mortgage.
Just remember that lenders look at more than just your LTV ratio when deciding whether to approve your refinance application. For example, you may technically be able to refinance into a VA mortgage with a high LTV ratio, but a lender could still reject your application if you have a poor credit score.
Having an LTV ratio low enough to receive refinancing approval is the first step. But there are other things to consider when calculating your ratio.
Lenders typically reward a low LTV ratio with a lower interest rate.
A lender may approve your application with a high LTV ratio if other parts of your financial portfolio are solid. Just know that the company could still charge you a higher interest rate, which will cost more in the long run.
Private mortgage insurance for conventional mortgages
If you’re refinancing into a conventional mortgage, don’t forget about private mortgage insurance, a type of insurance that protects the lender should you fail to make mortgage payments.
You’re probably already familiar with PMI if your initial mortgage was a conventional loan. If you’re refinancing from a different type of mortgage into a conventional mortgage, this may be a brand new concept.
You’ll have to pay for PMI if your LTV ratio is higher than 80% (meaning you own less than 20% of your home). You may want to consider waiting to refinance until you have enough equity to get a new mortgage with no PMI payments.
There are two basic ways to lower your LTV ratio: Pay down your mortgage, or increase your home value. Here are some ways to do both.
Wait it out
If you aren’t in a huge rush, consider holding off on refinancing until you’ve paid down your mortgage a bit. Depending on your situation, you could get your LTV ratio below 80% if you make payments for a few extra months before refinancing.
Waiting could also be useful if you think your home could increase in value. Maybe your neighborhood has been improving, or nearby property values are going up. The more your home is worth, the better your LTV ratio will be.
However, if you think your home could lose value in coming months, waiting could work against you.
Make extra mortgage payments
Can you afford to pay a little extra toward your mortgage before refinancing? Paying down more will decrease how much you owe on your home.
This strategy is probably only a good option if your lender doesn’t charge prepayment penalties, though. Some lenders require a fee if you pay off your mortgage early.
Invest in home improvements
You could increase your home value by making significant improvements, such as remodeling your kitchen or fixing the roof. Just ask yourself which will save you more money in the long run: Paying for improvements to secure a better deal on refinancing, or paying more to refinance now?
Understanding your LTV ratio can prepare you for the refinancing process, and hopefully get the best deal possible.