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As of early 2021, mortgage rates remain at historic lows. While some current homeowners continue to face challenging financial burdens due to the ongoing COVID-19 pandemic, those low interest rates coupled with many employers’ recent switches to full-time remote work have been driving housing markets in surprising places. For those who remain financially stable despite the vagaries of global, national, and local markets, there has never been a better time to refinance your home.

Those looking to refinance have a lot to untangle when it comes to understanding mortgage terms. Dustin DiMisa’s Twitter is a great source of ongoing updates and information about a wide range of financial services targeted toward current and future homeowners. For now, let’s focus on one important factor in determining whether to consider a refinance: loan-to-value (LTV) ratios.

What Are LTV Ratios?

LTV ratios are percentages that compare your remaining home loan to the value of the actual property. In layman’s terms, they show how much of the property you own compared to how much of its equity will be held by the bank until the mortgage is paid off.

How Lenders Use LTV Ratios

Lenders, including financial service companies that offer mortgage refinancing, use LTV ratios to determine a borrower’s eligibility and risk profile. A high LTV means the bank will be taking on more risk. A borrower’s risk profile has repercussions. If the bank determines that a borrower poses a high risk, it will usually respond by raising the interest rate. Higher interest rates mean larger monthly payments, and those larger payments, in turn, make it more less likely that refinancing will deliver benefits.

How High LTV Ratios Affect Borrowers

As most homeowners can likely see, high LTV ratios can create somewhat of a Catch-22.

Borrowers with high LTV ratios often wind up paying more interest, even if they have high credit scores. They’re often required to purchase private mortgage insurance (PMI), as well, which adds another level of monthly payments to the equations. Those extra monthly financial commitments make it harder for borrowers to pay their bills on time.  Mortgage companies institute higher costs on riskier loans to dissuade you from taking on too much debt.

How to Estimate LTV Ratios

Before investigating mortgage lenders, borrowers can estimate their LTV ratios to get a better idea of what to expect in terms of eligibility and interest rates. Estimating an LTV ratio is simple. Just divide the loan amount by the home’s appraisal value. To further clarify the process, let’s look at an example.

A buyer wants to purchase a home valued at $200,000. He or she can invest $40,000, or 20% of the total home value, into making the down payment. Subtract the down payment from the total loan amount to get $160,000. That’s the loan amount. Now, just divide $160,000 by $200,000 to get an LTV ratio of 0.80, or 80 percent. The borrower would own 20% of the home, while the bank would own 80% upon issuance of the loan.

What Is a Good LTV Ratio?

For most home owners, an initial LTV ratio of 80% is a good benchmark. Banks know that a homeowner who owns 20% of his or her property is statistically less likely to default on a loan than one who owns only 3%. As a result, they’ll typically offer lower interest rates with more favorable mortgage terms.

How to Lower an LTV Ratio

Homeowners who don’t bother to estimate their LTV ratios before putting in applications for loans may be in for some unpleasant surprises, from high interest rates to full-out denial of the loans. Thankfully, there are practical ways for future buyers to lower their LTV ratios before even contacting a bank. Here are a few things to try:

  • Put down a larger down payment by purchasing a less expensive home or saving for an extra year or two.
  • Make larger payments toward the principal each month to get a high LTV ratio under control over time and save money on interest.
  • Consider a lender that allows higher LTV ratios. Some government-backed loans can be issued even if buyers have LTV ratios of 100%, though they have strict eligibility criteria.

Every buyer’s situation is a little different, and there are no cookie-cutter approaches to improving financial situations. The best way to determine a path forward that won’t increase a future buyer’s risk of facing foreclosure is always to schedule an appointment with a financial consultant.

Lenders That Offer Mortgages to High-Risk Buyers

There are four government-backed options for buyers with high LTV ratios who aren’t willing or able to either wait until they can save up more for a down payment or look into less expensive homes:

  1. Federal Housing Administration (FHA) loans are available to eligible buyers with LTV ratios of 96.5% or less, but they require purchasing additional PMI policies.
  2. US Department of Agriculture (USDA) loans do not require a down payment, but they are only available in select rural locations.
  3. Veterans Affairs (VA) loans also allow LTV ratios of up to 100% but are only available to military personnel.
  4. Fannie Mae and Freddie Mac loans are backed by the Federal Housing Finance Authority. They allow low-income borrowers with LTV ratios of up to 97% to take out loans but require PMI until homebuyers’ LTV ratios fall below 80%.

The Bottom Line

The best way for future homebuyers to secure favorable terms and a low interest rate on a mortgage loan is to reduce their LTV ratios to 80% or less. Financial advisors can help potential buyers who can’t reach that goal post determine the best solutions for either improving their financial situations or finding a lender with lower eligibility criteria.

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