Lenders look at many factors when deciding if you qualify for a refinance. Among those factors, the LTV is one of the largest. The loan-to-value ratio shows a lender how much you owe compared to the home’s value. The less you owe, the better terms you might receive. Of course, the bottom line depends on all of the qualifying factors of your loan.
The exact LTV that you need to qualify for a refinance depends on the program you choose. The most common programs require the following LTVs:
- Conventional loans – 95%
- FHA loans – 97.5%
- VA loans – 100%
- USDA loans – 100%
These figures are the maximum LTVs these programs allow. But what if you have a lower LTV. Does it benefit you?
How a Lower Loan-to-Value Ratio Can Help
While the above LTVs are the maximum each program allows, that’s not what lenders want to see. Instead, they want an LTV that is as low as possible. The more money you have invested in your home, the more likely you are to make your payments.
A lower LTV can help you secure a lower interest rate and pay fewer closing fees. It may also mean the difference between a loan approval and denial depending on your other circumstances. For instance, do you have a low credit score or high debt ratio? These factors make you a high risk of default. If you combine that with a high LTV, you could end up without a loan approval. If, on the other hand, you have a low LTV, you may be able to secure the loan despite your high risk factors.
If you plan to take cash out of the equity of your home, different loan-to-value requirements prevail. Lenders take a higher risk when they allow you to tap into your home’s equity. Because of that, they often have lower LTV maximums for this type of loan. The following LTV requirements pertain to each loan program:
- Conventional loan – 80%
- FHA loan – 85%
- VA loan – 100%
Figuring Out the Best LTV
Each borrower will have a different LTV that is right for them. It depends on the other factors. You can use this basic rule of thumb, though. The higher your credit score and the lower your debt ratio, the more a lender will likely be willing to lend you. This means you can have a higher LTV and get approved.
If you have any factors that make your loan risky, meaning you pose a higher risk of default, a lender may restrict your LTV even more. For example, as you can see above, taking cash out of the home’s equity is risky. Lenders automatically cap the LTV at lower amounts, except for the VA loan.
Even if you don’t want to take cash out of the home, but you have a low credit score or high debt ratio, the lender will cap your LTV. They don’t want to lend you too much compared to the home’s value because your risk of default is higher. If you default, the bank is at a higher risk of losing money as selling a home as a foreclosure doesn’t often get the lender the full value of the home. The lender has to protect themselves against this risk.
While there isn’t a magic number for the best loan-to-value ratio for any loan program, the lower you can make your LTV, the better your chances of approval. You want to make sure all of your qualifying factors are as attractive as possible in order to get yourself the best loan possible.