Last Updated on May 24, 2022 by
Purchasing a new house is not a minor deal. If you are looking to buy a property, you would have considered getting a loan as well. However, some part of the purchase consideration is paid by you in advance, as the down payment. You borrow the rest of the amount.
Have you wondered how to calculate the down payment amount? How does that affect the risk that the lenders take? What affects the chances of your loan approval? What do lenders look into while deciding interest rates? The answer to all this can be partly understood using the LTV ratio.
Let us delve into the details.
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What is the LTV ratio?
Loan-To-Value (LTV) ratio is a financial tool used to determine the part of the property’s appraised value that you can fund by a loan. Moreover, it is an important metric that indicates the risk involved for the lender. It is also used to calculate the amount of down payment while purchasing a property. Let us see how to determine the value of the ratio.
How to calculate the LTV ratio?
LTV ratio is calculated by dividing the loan amount by the appraised value of the property. It indicates the percentage of borrowings in the total amount you pay for the purchase.
You can calculate the LTV ratio using the following formula:
LTV ratio = Amount of loan / Appraised value of the property.
Assume the appraised value of a house you wish to purchase is Rs. 80 lakh. You pay Rs. 8 lakh as a down payment. You borrow the remaining Rs. 72 lakh from a bank. This would mean:
LTV ratio = (72,00,000 / 80,00,000) = 0.9 = 90%
90% LTV implies that you must put 10% of the amount as a down payment. You can borrow the remaining 90%. The down payment plays an important role—the more the down payment, the lower the LTV.
Let us see how a lower LTV is beneficial for you.
What should your LTV ratio be?
When looking to buy a house, you cannot fully fund it by external sources. This means that your LTV ratio can never be 100%.
Ideally, the lower the LTV, the better. This is because more of your money is involved in the down payment, indicating a high personal stake in the investment on your end. It becomes less likely for the loan to go bad, increasing the lender’s trust.
An LTV of less than 80% provides some margin for lenders in case of fluctuations in the property’s value. The house serves as collateral against the loan. If you default and cannot repay the amount, the lender can recover the amount by selling the property. If the lenders extend a loan for a higher LTV, they would suffer a loss if the property’s value drops. Selling a share of it would not be enough to cover the loss they face.
However, this percentage is just what the lenders prefer in general. Many other factors that may affect the LTV limit include your credit score, level of debt, and income level. This affects the loan conditions and the chances of you availing one.
LTV rules by the RBI
RBI has produced new guidelines for the LTV ratio for home loans. LTV ratio can go up to 90% if the loan amount is Rs. 30 lakh or lower. For loan amounts between Rs. 30 lakh and Rs. 75 lakh, The limit is 80%. For a loan amount greater than Rs. 75 lakh, the LTV ratio can only be up to 75%.
The recent regulations have also altered the risk weightage depending on the LTV. For loan options where the LTV ratio is less than 80%, the risk weight is 30%. Similarly, loans with LTV between 80% and 90% attract 50% risk weight. Risk weights are linked to loan size as well as LTV. As RBI removed loan size from the equation till 31 March 2022, it has allowed banks to lend more without worrying about higher charges.
What does a high ratio mean for the borrower?
Lenders calculate the LTV ratio to determine the risk involved in giving out the loan. The simple rule is: higher the LTV ratio, the higher the risk. For borrowers, this may arise as a difficulty in getting the loan approved.
If the lender approves the loan, the common criterion is that you pay a higher interest rate. You may also have to pay additional charges. A common example is the requirement of insurance. This secures the loan in case you are unable to pay. However, it increases the overall cost of your borrowing.
The Loan-To-Value (LTV) ratio is the percentage of the property value that a financial institution like a bank or an NBFC can lend to you to finance your home purchase. A lower LTV ratio can assist you in getting better terms on a loan as it indicates lesser risk for the lender. Moreover, even though your background may allow you to avail of a higher loan, the LTV limits may cap the amount. It is thus advised to do your research and understand all RBI guidelines. You can calculate the LTV ratio yourself.
For more complex situations where calculations may be tricky, you can use an online LTV calculator.