Are you planning to buy a property through a home loan? In this process, you will come across several technical terms related to loans and mortgages. One such term is “Loan-to-Value” (LTV).
When you take a home loan, you usually do not get 100% of the property amount from the bank. The LTV ratio tells you how much of the property’s value the bank is willing to finance through the loan.
Want to understand it better? In this article, we will learn what the LTV ratio means, how it is calculated, and why it matters. We will also look at the pros and cons of a high LTV ratio and how it affects your home loan eligibility.
What is Loan-to-Value (LTV) ratio?
LTV stands for loan-to-value ratio, is the ratio of loan to the market value of purchased house or the property which is pledged as collateral. It is a financial indicator used by lenders to assess the risk associated with a home loan. Simply put, it represents the proportion of the property's value that you are borrowing through the loan.
While taking a home loan is the most practical decision, you may want to understand the key principles that define your eligibility for it. Amongst many, the Loan-to-Value ratio (LTV) is an important criterion that influences your eligibility. In essence, this ratio also derives the down payment you would make against the total value of your home.
What is the LTV according to RBI?
Per the RBI, the loan-to-value (LTV) ratio is the maximum percentage of an asset’s value that a lender can offer as a loan. This limit or percentage is set by the RBI. Let’s understand in detail:
LTV for home loans
The RBI has fixed different LTV limits based on the value of the property:
Property value |
Maximum LTV limit |
Self-contribution (of the property cost) |
For properties worth up to Rs. 30 lakhs |
90% |
10% |
For properties priced between Rs. 30 lakhs and Rs. 75 lakhs |
80% |
20% |
For properties above Rs. 75 lakhs |
75% |
25% |
All banks and NBFCs in India must follow these LTV rules.
If you are planning to purchase your dream home and need financing within these LTV guidelines, Bajaj Finserv offers competitive home loans with interest rates starting from 7.49%* p.a Check your eligibility today. You may already be eligible, find out by entering your mobile number and OTP.
LTV for gold loans
For loans against gold, the RBI allows a maximum LTV of 75%. So, if your gold is worth Rs. 1 lakh, the bank can give you a loan of up to Rs. 75,000.
However, during the COVID-19 pandemic, the RBI temporarily raised the LTV for gold loans to 90%. This was done to ease financial pressure on borrowers. Be aware that this has now been rolled back.
Why does the RBI set LTV limits?
By setting the LTV, the RBI can control the risk of lenders. As per a general industry understanding, the higher the LTV, the higher the lending risk, and vice versa.
When the LTV is kept low and the asset’s value drops, the lender is protected. That’s because the borrower has already paid a part upfront. This reduces the lender’s risk, as the loan amount is less than the asset’s full value. At a later stage, it also ensures better recovery in case of default.
How to calculate Loan-to-Value ratio
Calculating the Loan-to-Value (LTV) ratio is straightforward. It's the ratio of the loan amount you're seeking to borrow to the appraised value or purchase price of the property, whichever is lower. Here's how to calculate the LTV ratio:
LTV ratio formula
LTV ratio = (Loan amount) / (Property value or purchase price, whichever is lower)
For instance, if you are purchasing a home valued at Rs. 2,00,000 and your lender offers you a loan of Rs. 160,000, the LTV ratio would be calculated as follows:
LTV ratio = (Loan amount / Property value) * 100 LTV Ratio = (Rs. 1,60,000 / Rs. 2,00,000) * 100.
LTV ratio = 80%.
In this scenario, the LTV ratio is 80%. It means you are financing 80% of the property's value through the home loan, and the remaining 20% will be covered through your down payment.
Significance of the LTV ratio in Home Loan
The LTV ratio is important for both borrowers and lenders. Here is why:
- Risk assessment: Lending institutions use the LTV ratio as a risk indicator. A higher LTV ratio shows that a borrower is requesting a substantial portion of the property value through the home loan, which poses a higher risk for the lender. On the contrary, a lower LTV ratio suggests that the borrower is making a more substantial down payment, minimising the risk for the lender.
- Loan eligibility: Most lenders have a maximum LTV ratio they are willing to accept. For example, if a lender's maximum LTV ratio is 80%, it means they will not provide a loan amount that exceeds 80% of the property's value. So, in case your LTV ratio is higher than 80%, the lender may not consider your application eligible.
- Interest rates and terms: LTV ratio can also influence the terms of the loan, including the interest rate. Generally, borrowers with a lower LTV ratio could qualify for more favourable interest rates. As it is known that a low LTV poses a lower risk to the lender.
- Private Mortgage Insurance (PMI): When the LTV ratio exceeds a certain threshold (typically 80%), lenders often require borrowers to pay for Private Mortgage Insurance (PMI). PMI protects the lender in case the borrower defaults on the loan. It adds an extra cost to the borrower's monthly payments.
Some tips for managing your LTV ratio
- Save for a larger down payment: By making a more substantial down payment, you can reduce the loan amount thereby the LTV ratio. This may lead to better loan terms and save you money over the loan tenure.
- Property valuation: Before applying for a home loan, conduct thorough research on the property value you plan to buy. You must note that a property with low evaluation can increase the LTV ratio, potentially affecting your loan approval and interest rates.
The Loan-to-Value ratio (LTV) is a crucial factor in the home loan application process, influencing your eligibility, interest rates, and loan terms. As a home buyer, understanding how LTV works and managing it effectively can help you secure the best possible loan options.
Role of LTV ratio in determining eligibility
The Loan-to-Value (LTV) ratio plays a crucial role in determining eligibility for loans, especially in the context of mortgage lending. LTV is a financial term that expresses the ratio of a loan amount to the appraised value of an asset, often a property. Here's an overview of the role of LTV ratio in determining eligibility:
- Definition of LTV ratio: The LTV ratio is calculated by dividing the loan amount by the appraised value of the asset. For example, if a borrower seeks a mortgage of Rs. 80,000 on a home appraised at Rs. 100,000, the LTV ratio would be 80%.
- Risk assessment: LTV ratio is a key metric for lenders to assess the level of risk associated with a loan. A higher LTV ratio indicates a higher percentage of the property's value is financed, posing a greater risk to the lender.
- Loan approval: Lenders use specific LTV thresholds to determine loan eligibility. Different loan types and lenders may have varying acceptable LTV ratios. Generally, a lower LTV is seen favourably by lenders as it signifies a lower risk.
- Down payment requirement: The LTV ratio is inversely related to the down payment. A lower LTV implies a higher down payment, which is often a positive factor in loan approval. For instance, an 80% LTV means a 20% down payment.
- Risk mitigation: Lenders often set maximum LTV limits to mitigate risk. A lower LTV reduces the lender's exposure in case of default, as there is more equity in the property.
- Loan terms and interest rates: LTV ratios can influence the loan terms and interest rates offered to borrowers. Lower LTV ratios may result in more favourable loan terms, including lower interest rates and better repayment terms.
- Private Mortgage Insurance (PMI): In situations where the LTV ratio exceeds a certain threshold, lenders may require borrowers to obtain Private Mortgage Insurance (PMI). PMI protects the lender in case of default but adds an additional cost for the borrower.
- Impact on high-value properties: For high-value properties, where the loan amount is a significant portion of the property value, the LTV ratio becomes critical. Lenders may be more conservative in approving loans for such properties.
- Home equity loans and lines of credit: LTV ratios also play a role in home equity loans and lines of credit. These financial products allow homeowners to borrow against the equity in their homes, with LTV influencing the borrowing limits.
- Market conditions: Economic conditions and the real estate market can impact LTV ratios. During periods of economic downturn or declining property values, lenders may become more conservative and adjust acceptable LTV thresholds.
Pros and cons of a high LTV ratio
Pros of a high LTV ratio:
- Lower initial cash requirement: Enables a lower down payment, making homeownership more accessible.
- Easier entry into the housing market: Facilitates entry for those with limited savings, expanding opportunities.
- Increased buying power: Expands purchasing options for more expensive properties.
- Potential for home value appreciation: If property values rise, a high LTV becomes more favourable over time.
Cons of a high LTV ratio:
- Higher risk for lenders: Poses increased risk for lenders, particularly in economic downturns.
- Risk of negative equity: Raises the likelihood of owing more than the property is worth.
- Requirement for Private Mortgage Insurance (PMI): Lenders may mandate PMI, adding extra costs for borrowers.
- Higher interest rates: Borrowers may face elevated interest rates due to perceived risk.
- Limited loan terms and options: Can result in restrictions on favourable loan terms and options.
- Reduced equity build-up: Slows down the accumulation of equity in the property.
- Impact on refinancing: Affects the ability to refinance at more favourable rates or terms.
In summary, while a high LTV ratio offers advantages like lower upfront costs, it also brings substantial risks and potential limitations that borrowers should carefully consider.
LTV ratio in home loans vs. other loans
The loan-to-value ratio is used by lenders to decide how much loan they can give compared to the value of the asset being financed. It is more relevant in secured loans where there is a specific asset (like a house or car) that acts as security or collateral.
Let’s learn how the LTV ratio varies across different types of loans:
Home loans
In home loans, the LTV ratio decides the maximum loan amount a borrower can get based on the value of the property.
For example,
Say the property is worth Rs. 50 lakhs.
The bank has a maximum LTV of 80%
Now, the bank will lend up to Rs. 40 lakhs.
The remaining Rs. 10 lakhs must be paid by the borrower as a down payment.
Additionally, LTV also affects eligibility. A lower LTV means the borrower is taking on more of the cost, which lowers the risk for the bank. Thus, a lower LTV usually allows the borrower to secure better interest rates.
Auto loans
Auto loans are also secured loans, but the asset (the vehicle) loses value over time due to depreciation. Because of this, lenders often apply stricter LTV limits for auto loans than for home loans.
That’s because the lender wants to ensure the loan amount doesn’t exceed what they could recover by selling the car (if needed in case of default).
Personal loans
Personal loans are unsecured, as there is no asset involved as collateral. Since there is no asset, the concept of LTV does not apply here.
Instead, the lender checks your:
Income
Credit score
Repayment history
After analysing these factors, they decide how much to lend.
LTV ratio and home loan eligibility
When you apply for a home loan, the LTV ratio decides how much loan you are eligible for. So, even if your income is high and you qualify for a larger loan, the bank cannot offer more than what the LTV guidelines allow. Banks must follow the limits set by the RBI.
At the same time, a lower LTV ratio (where you contribute a larger portion of the property's cost) works in your favour. It reduces the risk for the lender. As a result, you may be offered better loan terms, such as a lower interest rate.
Now that you understand how LTV affects your loan eligibility and terms, it is time to explore your home financing options. Bajaj Finserv provides home loans up to Rs. 15 Crore* with quick approval in 48 hours*. Check your eligibility for a home loan that suits your budget. You may already be eligible, find out by entering your mobile number and OTP.
Important links: What is Home Loan | Home Loan Interest Rates | Home Loan Eligibility Criteria | Documents Required for Home Loan | Home Loan Balance Transfer | Joint Home Loan | Home Loan Tax Benefits | Home Loan Subsidy | Housing Loan Top Up | Rural Home Loans | Home Loan Process | Down Payment for Home Loan | Pre-approved Home Loan | Rural Home Loan | Home Loan Tenure
Conclusion
Now that you understand the LTV ratio, you can better plan your home purchase. Through LTV, you can calculate how much funding you can secure and what you must pay as a down payment.
Please note that LTV affects:
Your loan eligibility
The interest rate you may get
The risk taken by the lender
The knowledge of how LTV works across different loans (home, auto, and personal loans) further avoids surprises during the loan process. So, always plan your budget keeping LTV limits in mind! With a clear understanding of LTV ratios, you can make informed decisions about your home loan. Bajaj Finserv offers competitive rates and flexible terms to help you secure the perfect home loan. Check your loan offers and take the first step towards your new home. You may already be eligible, find out by entering your mobile number and OTP.
