What does a Loan-to-Value (LTV) ratio indicate in mortgage lending?

A Loan-to-Value (LTV) ratio is a crucial metric in mortgage lending that indicates the proportion of a property’s value that is financed by a mortgage. This ratio is calculated by taking the loan amount and dividing it by the appraised value (or purchase price) of the property, then expressing that value as a percentage.

For example, if a borrower is purchasing a home worth $300,000 and they take out a mortgage of $240,000, the LTV ratio would be 80% (i.e., $240,000 ÷ $300,000). A higher LTV ratio suggests that the borrower is financing a larger portion of the property's value, which may indicate higher risk for lenders. They may perceive a borrower with a higher LTV ratio as a higher risk because there is a smaller equity cushion, which could impact loan terms, such as interest rates or required mortgage insurance.

Understanding the LTV ratio is critical for both lenders and borrowers, as it affects loan approval decisions, interest rates, and the overall affordability of financing a property.