Why understanding the loan to value ratio while buying property is crucial?

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Loans and mortgages have a slew of jargon associated with them, such as “house loan,” “project finance,” “gold loan,” and “auto loan.” The Loan to Value Ratio (also known as the LTV Ratio) is one such important word. So, let’s understand the LTV ratio:

You can calculate the amount of money that can be borrowes based on the loan-to-value ratio (LTV) or loan-to-cost ratio (LTC). It defines the maximum loan amount based on the market value and liquidity of the collateral pledged in the case of a secured loan.

Simply put, borrowers provide lenders a claim on the asset if they are unable to repay the loan at any point in time. LTV informs the loan applicant of the maximum percentage of the pledged asset’s worth that he can borrow.

How is it calculated?

Loan-to-Value Ratio is calculated as : LTV = (loan amount/appraised asset’s value) x 100

If a borrower urgently seeks a loan against a property worth Rs 50 lakh and the lender confirms that the amount to be sanctioned is Rs 40 lakh, then the LTV ratio will be as follows – LTV = (Rs 40 lakh/Rs 50 lakh) x 100 = 80%. According to the example above, the lender would authorise Rs 40 lakh. Lenders calculate the LTV after evaluating the value of the pledged asset.

For instance, if the pledged asset is a brand-new home built in a premium location, the loan amount secured by the property is more (75% – 80%). On the other hand, older properties that may be more difficult to sell or whose value may decline are eligible for lesser loan amounts.

What it means for the borrowers?

A higher LTV ratio is more profitable for the buyer, as it enables the buyer to process the loan more rapidly. At the initial level, the borrower obtains the largest amount of finance available, thereby immediately advancing the borrower up the ladder for the goal for which credit is being obtained. Additionally, the higher LTV enables the borrower to negotiate a longer loan term and a lower interest rate.

What it means for the lender?

From the lender’s standpoint, a lower LTV is preferable because it forces borrowers to provide more of their funds, implying a stronger level of commitment on the borrower’s part. However, lenders promise that interest rates will remain high to mitigate the risk of a higher LTV ratio.

However, on the cautious side, lenders consider that older asset that has depreciated in value may become a problem for them to resell in the event of default and may reject the loan application entirely in such situations.

End note

The LTV ratio is a critical indicator for determining the lending risk a lender assumes while issuing a loan that meets the borrower’s requirements. While evaluating the borrower’s loan proposal, the ratio analyses the size of the loan requested to the size of the collateral pledged. Thus, assessing both sides through the lens of the LTV ratio is critical.