How Does a Loan-to-Value Ratio Get Calculated?
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What Does Loan to Value Mean
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There are many mortgage products on the market today. Each product has its own loan to value limit on it. Depending on the money a person has for a down payment, the mortgage officer will try to fit her into a program that will accommodate her. The meaning of loan to value is the ratio between the amount of the loan someone is requesting and the value of the property for which the loan is requested.
Calculating Loan to Value
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Let's say Bob sees a house he wants to buy that has an appraisal for $100,000. He applies for a mortgage and the program with the best rate has an 80 percent LTV. Multiply the $100,000 times the 80 percent and the maximum loan allowed would be $80,000. This would mean that Bob needs $20,000 for his down payment. If Bob only has $10,000 for a down payment he would need a program with a 90 percent LTV, likely a higher interest rate and private mortgage insurance. Whenever you borrow more than 80 percent of the value you will pay a mortgage insurance premium, most likely for at least five years. This makes your monthly payment a little higher but most people don't mind if it means they can buy a home.
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Loan to Value Disasters
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One of the major problems with Loan to Value calculations is they are done when a loan officer takes an application. At that point it is very rare that an appraisal has been done recently. This mean the value is the best opinion of a Realtor or owner. The appraisal is done when all the credit and verifications are completed on the loan. If the appraisal comes in with a lower value than originally expected, either the buyer has to come up with more money, the seller has to take less or the transaction is voided. This can lead to major heartache for both buyer and seller. Although this is rare, it happens more in a declining market. The other disaster is the 125% LTV home equity loans. Many people, figuring the value of the house would go up in a few years, took out these types of loans. Now they owe more than their house is worth.
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