What is the loan-to-value ratio and how does it affect your mortgage refinance?

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Your loan-to-value (LTV) ratio plays an important role in determining whether or not you qualify for a mortgage refinance. Find out what it is and how it works. (Shutterstock)

A mortgage refinance replaces your current home loan with a new one. Several factors affect your refinance rate and monthly payment, including your loan-to-value (LTV) ratio.

Here’s an overview of what LTV is, how to calculate it, and how it can affect your mortgage refinance.

Credible, it’s easy to research your mortgage refinance options and compare rates from multiple lenders.

What is a loan-to-value (LTV) ratio?

Your LTV ratio compares the market value of your home to your mortgage balance. Mortgage lenders often use this ratio to determine your eligibility for a loan.

If you take out a traditional loan and your LTV ratio is above 80%, i.e. you have less than 20% of your home equity – you will be responsible for private mortgage insurance (PMI) until your LTV ratio drops to 80%.

A higher LTV could position you as a riskier borrower since you have less money invested in the home, while a lower LTV can increase your chances of being approved and getting a great rate.

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How to calculate your LTV ratio

To calculate your LTV ratio, divide your mortgage balance by the appraised value of your home and multiply that value by 100.

Loan balance ÷ home appraised value x 100 = LTV ratio

Let’s say you have to $200,000 on your mortgage and your property is worth $300,000 — you would have an LTV ratio of 66%.

You can determine the value of your home through a professional home appraisal, or get an estimate from a real estate agent or an online appraisal tool.

How does your LTV affect refinancing?

When it comes to your ability to refinance, your LTV ratio is one of the most important factors. If a lender receives your application and learns you have an LTV over 80%, they may charge you higher mortgage insurance and fees — or deny your application outright.

Your LTV will also help determine your interest rate. If you have a higher LTV, you will likely receive a higher rate. Other factors that can affect your mortgage rate and monthly payments include your credit score, debt-to-income ratio (DTI), employment history, repayment period, and type of refinance (standard or cash).

LTV ratio requirements

You have a number of refinancing options available to you. the terms, including maximum LTV, vary by program. Here is an overview of the most common refinance programs and their ideal LTV ratios.

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How to improve your LTV ratio before refinancing

A lower LTV ratio can help you get approved for a refinance and get a better rate that saves you money over the life of your loan. If your LTV ratio is higher than you would like, you can reduce it in several ways, including:

  • Pay off your mortgage. As you make your mortgage payments, your LTV will decrease. To speed up the process, consider payments every two weeks or put extra money from bonuses and tax refunds, for example, on your balance.
  • Wait for the value of your home to increase. The value of your home is bound to fluctuate. Factors like a healthy economy and high demand in your neighborhood can cause your home to naturally appreciate.
  • Renovate your home. Investing in home improvements can increase the appraised value of your home. However, not all renovations are created equal, so focus on the projects that offer the best return on investment.
  • Pay the initial closing costs. If you can afford it, you might want to cover your closing costs upfront. By doing so, you can reduce the total amount of your loan. Note that closing costs generally vary between 2% and 5% of the mortgage.
  • Opt for a standard refinance. Although a standard refinance will not allow you to leverage the equity in your home as you would with a cash-out refinance, you will be able to keep your mortgage balance low.

Shopping around with different lenders is one way to ensure you get a great refinance rate. Credible can help you easily compare refinance options.

Factors that can worsen LTV ratios

Your LTV ratio can increase in a number of situations and make it harder to refinance your mortgage.

Decrease in property value

If you fail to maintain your home over time or if there is a drastic drop in the local real estate market, your LTV will likely increase. The current value of your home may fall below your loan balance – this is called being underwater or upside down on your mortgage. In this case, you are unlikely to qualify for a refinance.

Bad review

To refinance your mortgage, you will need a home appraisal. A low appraised value instantly worsens your LTV ratio and can negatively affect the mortgage rate you receive. It also reduces the amount of money you can take out in a cash refinance. If your appraisal is low, challenge any inaccurate remarks and invest in repairs so that your second appraisal leads to a higher value.

Second mortgage

If you have a second mortgage like a home equity loan or HELOC, you may find it harder to refinance your first mortgage. To achieve the correct LTV ratio for refinancing, you may first need to reduce or pay off your second mortgage.

Refinancing by collection

A cash refinance replaces your current mortgage with a new, larger loan and lets you pocket the difference in cash. Although you may get a lower rate than a personal loan and you can use the money for virtually anything, your LTV ratio will increase.

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High LTV Mortgage Refinances

If you have a high LTV ratio, don’t worry. You have the choice between several refinancing options, such as:

  • Fannie Mae RefiNow — A RefiNow loan requires a current Fannie Mae mortgage. You’ll also need an LTV ratio of 97% or less, a debt-to-income ratio of 65% or less, an income at or below 100% of your region’s median income, and a score of minimum credit of 620.
  • Freddie Mac Refi Possible — Thanks to Refi Possible, you can be approved with an LTV ratio of 97% and up to 65% DTI. You must also earn a low to moderate income and have a credit score of at least 620.
  • FHA streamlines refinancing — There is no minimum LTV ratio on an FHA rationalization. But if your LTV is 90% or less, you can waive annual mortgage insurance premiums after 11 years.
  • WILL streamline refinancing – Also known as a VA Interest Rate Reduction Refinance Loan (IRRRL), a VA Streamlined Refinance comes with a one-time finance charge of 0.5%. The biggest advantage, however, is that you won’t have to pay for mortgage insurance. This program is for VA borrowers only.
  • USDA streamlines refinancing – USDA Streamlined Refinance is designed for USDA direct and guaranteed loan borrowers. Your new loan should reduce your monthly payment by at least $50. You can get approved without a home appraisal, regardless of your LTV, as long as you’ve made your last 12 payments on time.

If you’re considering refinancing your mortgage, it’s a good idea to compare offers from several lenders. With Credible, you can see your prequalified rates for conventional refinancing in minutes.

Sallie R. Loera