Understanding the Loan to Value Ratio
These days many renters are taking advantage of the present low
level of interest rates to get into a home of their own. In
addition, many current homeowners are taking advantage of those
same low interest rates to refinance their home mortgage loans
at more favorable interest rates. Therefore, whether you are a
current renter moving into a home of your own or a long time
homeowner seeking a lower interest rate, it is important to
understand one of the most important financial formulas - the
loan to value ratio. The easiest way to understand the loan to
value ratio is that it represents the relationship between the
amount of the outstanding mortgage as compared to the current
value of the home. Since housing prices have been rising very
fast in many areas of the country, many current homeowners have
built up quite a bit of equity in their homes. Many homeowners,
for instance, find themselves in the happy circumstance of
owning a home that is worth substantially more than they paid
for it, or substantially more than they owe on it. This means
that the homeowner has equity that can be used to borrow
additional funds, refinance the mortgage or even shorten the
term of the mortgage loan. It is fairly easy to calculate the
loan to mortgage ratio. It simply requires knowing approximately
how much your home is worth, the amount of the outstanding
mortgage and the amount of the original down payment. For our
exercise we will use a home value of $150,000. The approximate
value of your home can be estimated by looking at what similar
homes in your neighborhood have sold for. When calculating the
loan to value ratio, the first step is to take the original
purchase price of the home, in this case $150,000 and subtract
out the amount of the original down payment. For this exercise
we will use a down payment of $20,000. The loan to value ratio
is calculated by subtracting the $20,000 down payment from the
purchase price of $150,000. In this case the resulting number is
$130,000, which represents the $150,000 purchase price minus the
$20,000 down payment. Dividing the $130,000 loan amount by the
$150,000 purchase price gives us a loan to value ratio of 0.87,
or 87%. It is important to know your loan to value ratio, since
this number will be important to lenders any time you apply for
a loan.
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