We love every opportunity to show our guests the many Hot Springs Village homes for sale. We enjoy introducing prospective buyers to both the community and the surrounding area. But sometimes those buyers aren’t exactly sure what they are getting themselves into. They do not understand the basics of home buying. Take lender LTVs. Buyers often don’t understand them.
This post will explain everything you need to know about lender LTVs. If you can get a handle on this concept, you will be better prepared to understand your own financial position going into your next home purchase. And if that purchase happens to be here in Hot Springs Village, we will be happy to welcome you aboard.
Loan-to-Value Ratio
LTV is an acronym that stands for ‘loan-to-value’. It is a tool through which lenders determine the amount of money they will loan based on the value of the property in question. Establishing an LTV ratio accomplishes two things:
- it allows lenders to put an arbitrary cap on the amount of money they will lend, and
- it tells buyers how much of a down payment they will need to bring to the table.
The LTV concept is based in one of the most fundamental rules of lending. That rule states that lenders should never lend more than the value of whatever asset backs up the loan. Otherwise, lending becomes too risky.
The Practical Implementation of LTV
To help you understand the practical implementation of LTV, let us create a fictional scenario. Assume John and Mary want to buy Hot Springs Village real estate in anticipation of moving to the area. They are looking at a property listed at $400,000. Their preferred lender has a standard LTV of 75%.
This dictates that the bank will lend, at the most, $300,000. That is equal to 75% of the property’s list price. Assuming the property appraises for at least $400,000, the lender can see a way forward.
John and Mary would need to come up with the remaining $100,000 on their own. That would be their down payment, equal to 25% of the list price. As for points, closing costs, mortgage insurance, etc., whether these were rolled into the mortgage would depend on the deal negotiated by lender and borrower.
100% Is Hard to Find
These days, it is hard to find lenders offering a 100% LTV ratio. Such lenders may not even exist. However, things were different 20 years ago. Back then, the number of lenders willing to fully finance the purchase of a home was significant.
Those were the days when everyone wanted to build a McMansion. It was a time when the government was pushing home ownership as the only measure of success. People were led to believe that they had not achieved the American dream if they had not bought a home.
The environment of the day led to far too many banks writing mortgages to buyers who could not afford them. Lenders also tended to offer exceptionally high LTVs. But in the end, it all came crashing down and the bottom fell out in 2007-2008. Everything changed when it did.
Better Risk Management Today
One of the end results of the 2007-2008 housing crash was a greater appreciation for risk management. Through new bank regulations and some soul-searching in the banking industry, new standards were developed. Those standards all but eliminated the 100% LTV.
In short, the LTV ratio expresses how much lenders are willing to lend compared to the value of the property in question. It reduces lender risk and gives home buyers a concrete number for determining down payment requirements.