Understanding Loan-to-Value Ratios

A loan-to-value (LTV) ratio is a tool that helps the lender determine the financial risk when considering whether to approve a mortgage for borrowers. In the context of a reverse mortgage, the LTV determines the amount of money a borrower can receive during the life of the loan. Here is a guide to understanding loan-to-value ratios:

What Is Loan-to-Value Ratio?

LTV is a calculated ratio that compares the loan amount to the appraised value of the property. The LTV in the reverse mortgage is the percentage of the appraised value a borrower can receive as loan proceeds for the property.

The higher the LTV ratio, the less equity the borrower will be able to access from the home. 

How to Calculate Loan-to-Value Ratio

Calculating LTV is complicated, and borrowers will likely consult a lender to learn their definitive ratio. To get a ballpark figure, however, to calculate an LTV, divide the loan amount by the appraised value. An appraiser will determine the appraised value independently.  The loan amount, calculated separately, is based on multiple factors, including the youngest borrower or non-borrowing spouse’s age, the appraised value of the property, and the interest rate. 

Here is an example of how to calculate the LTV ratio in a reverse mortgage:

If the appraised value is $400,000 and the borrower is eligible for $250,000 based on age, interest rate, and other factors on the loan, the calculation would work out as follows:

The LTV ratio = Loan Amount/Appraised Value of the Property 
LTV ratio = $250,000/$400,000
LTV ratio = 0.625 or 62.5%

In this example, the LTV ratio is 62.5%, which means the borrower can receive up to 62.5% of the appraised value of their property as a reverse mortgage loan. 

Factors Impacting the Loan-to-Value Ratio

Various factors influence the LTV ratio. These include, but are not limited to, the following: 

  • Age of the Borrower. The older the borrower, the higher the LTV ratio. The lender assumes the loan will be outstanding for a shorter period before repaying it.
  • Interest Rates. In most cases, loan balances grow slower when the interest rate is lower. This results in a higher LTV ratio. 
  • Home Value. If the property is appraised at a higher value, the LTV ratio will likely be higher, and the borrower can get more money. 
  • Type of Loan. A home equity conversion mortgage (HECM) insured by the Federal Housing Administration (FHA) usually has a higher LTV ratio than a proprietary mortgage. 
  • Loan Balance. If the borrower has an existing lower loan balance, the LTV ratio is higher.

What Are the Implications of a High Loan-to-Value Ratio?

Though borrowers don’t have any control over their LTV ratio, it’s useful to understand how it impacts the loan. The following are some of the ways a higher LTV ratio comes into play in a reverse mortgage.

  • Borrowers can access more equity. With a high LTV ratio, the borrower can access more equity in their home for house renovations, medical expenses, or vacations.
  • Limited options for the future. Accessing large amounts of equity all at once may mean that if the borrower has to move out or sell the home, there are limited options for using the remaining equity. 
  • Higher interest payments. A higher LTV ratio means paying higher interest rates throughout the loan, and this could reduce the amount of money for the borrower. 
  • Higher monthly payments. With a higher LTV, the borrower will likely receive larger monthly payments over the loan. This could be helpful for seniors who live on a fixed income and need help with day-to-day expenses.