Loan to Value Ratio
Finding your dream home isn’t easy, and financing it is even more challenging. That brings us to one of the more important factors in determining the rate of your mortgage, the dreaded down payment.
While there are a number of factors that may influence how much you put down on your new home, the loan-to-value ratio can play a major role. The “loan-to-value ratio,” often abbreviated as “LTV”, is the loan amount represented as a fraction of the purchase price or appraised value, whichever is lower.
So if you decide to put down the traditional 20 percent on a home (now probably 10 percent), you’d be looking at a LTV ratio of 80 percent, which is the remainder of the balance. Similarly, if you put 10 percent down on a home, the LTV would be 90 percent.
When mortgage lenders or banks determine your interest rate, LTV is a major factor, just as credit score (what credit score do you need to buy a house?), documentation type, and property type are. But LTV is arguably even more important because it creates pricing adjustment tiers.
For instance, a LTV of 65 percent and below will have different pricing adjustments than a LTV of 80 percent. So if you’ve got a credit score of 660, a LTV of 65 percent or below may have no associated interest rate adjustment. But at 80 percent LTV, the pricing hit may be .50%, which would raise your rate from say 6% to 6.5%.
That’s why it is imperative to take note of the different LTV thresholds and adjust your down payment accordingly, if possible. You certainly wouldn’t want to put 19 percent down instead of 20 percent, as you’d fall into a higher pricing tier.
For this reason, some borrowers choose to break their loans into two separate amounts, effectively lowering the LTV. Assume you put just 10 percent down on a new home, but pricing at 90 percent LTV is horrendous. Instead of opting for one high cost loan, you could instead break the loan up into an 80 percent first mortgage and a 10 percent second mortgage.
This would keep the LTV on the first loan at 80 percent, which would result in better pricing. The second mortgage would have a LTV or 10 percent, and a combined loan-to-value (CLTV) of 90 percent. And the blended rate between the first and second mortgages could actually result in greater savings than the one loan itself.
Just be sure to remember when deciding what down payment to put down on a house, you have enough assets left over to cover closing costs and at least two months of reserves for subsequent mortgage payments, as this will typically be the minimum requirement from the issuing bank or lender.