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Explainer | What is loan-to-value ratio and why is it important?

Often home loan borrowers come across several criteria set by lenders, mainly related to annual income required to be eligible for a home loan, minimum down payment to be raised by borrower, a good credit score, etc. Besides this, one of the important criteria in home loan is the lender’s maximum loan-to-value (LTV) ratio. Let’s understand what is loan-to-value ratio.

Meaning

LTV ratio is the proportion of the property value that a lender can finance through a loan. This ratio is used by financial institutions (banks, housing finance companies, non-banking finance companies) to assess their risk in lending a home loan to you as a borrower.

The core purpose of using LTV ratio for a lender is to calculate that they do not lend higher amount than actual price of the property. For a lender, if LTV increases the perceived risk of borrower default increases.

Loan-to-Value is calculated as follows:

Financial institutions calculate LTV of a borrower using given method: (Amount borrowed / Value of property) x 100 = LTV ratio in percentage

For instance, if you are buying a home valued at Rs 1 crore, and your bank’s LTV ratio is 70 percent, then the maximum loan the bank can give you is Rs 70 lakh.

Reserve Bank of India (RBI) guidelines

According to RBI guidelines which is fixed for financial institutions, LTV ratio in case of home loans of Rs.30 lakh or less can go up to 90 percent of the property value. A 90 percent LTV means that the borrower will have to shell out at least 10 percent of the property value out of his own pocket while the rest can be financed through loans. For loans between Rs 30 lakh and Rs 75 lakh, LTV ratio can go up to 80 percent while for loans above Rs 75 lakh, the required LTV ratio is 75 percent. Take into account the LTV ratio in order to find your minimum down payment.

Lender limits the home loan eligibility to 75 percent to 90 percent under RBI guidelines. With this limits, lender protects itself from the possible downturn (correction) in the prices of a property and in scenario when the borrower is not in a position to repay the equated monthly installment (EMI) on loan in future.

Lower the Loan-to-Value ratio is better for borrower

The lower the LTV ratio, the better the other terms and interest rates on your home loan. You will get to know your LTV ratio from lender while applying for a loan. With lower LTV ratio you should negotiate with your lender for lesser interest rates, higher tenure of loan (if required).

For example, a home loan with LTV of 60 percent would be offered with a lower interest rate from lender (require negotiation in case financial institution do not offer lower interest rate on home loan). This is because the more of own money used in down payment to make the purchase of a home, the lesser is a risk for the lender.

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