LOAN TO VALUE RATIO
At its most basic the loan to value ratio is the ratio of the amounts of loans you have on a property to the value of the property itself.
Here is a mortgage loan scenario:
you owe $80,000 on a first loan
you owe $10,000 on a second loan
the property is worth $100,000
the total loans on the property are $90,000
the loan to value ratio is 90% ($90,000 loans/$100,000 property worth)
Often times you will hear the combined loan to value (CLTV) ratio. This just means the combined first and second loans as a percentage of the property. The first and second loans are stated separately because often the interest rates on them are different. The rate of second mortgages is usually much higher.
The higher the loan to value ratio is the higher the loan's value is as a portion of the property value. As such, the higher the loan to value ratio is the lower the amount of equity there is in a property.
Lenders base their interest rates in part on risk. If a property has a lot of equity then a mortgage on that property is a lower risk for a lender. In the event of a mortgage default they can simply repossess the property. There is enough equity in the property that the lender can recoup their losses. For example, if a lender makes a loan for $250,000 on a property worth $500,000 then if they have to repossess it they will likely be able to sell the $500,000 property for at least the $250,000 that they need to recoup their loan.
The loan to value ratio is used by lenders to determine the interest rate, in conjunction with other factors such as credit, income, assets, etc.
It is important to understand that the loan to value ratio of a property can change over time even if the loan size remains the same. If the value of the property rises and the loan value remains the same, then the loan to value ratio will decline. Equity is increasing in the property because its value is going up.
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