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HOW LOAN-TO-VALUE RATIO IS IMPORTANT WHILE APPLYING A LOAN?


Well, there are number of technical terms associated with loans and mortgages, either it is a home loan, gold loan, loan against property or even a used car loan. One of such relevant terminologies is Loan-to-Value ratio. Let us take a deep dive into what a LTV ratio is, how it works and the difference it creates to both lender and borrower when they "Apply For Loan". One must consider its importance and understand how it works.

  • Loan-to-Value ratio: This term is as simple as it sounds. It determines the maximum quantum based on the market value and liquidity of the collateral pledged as a security for the loan. In simpler terms, borrower gives the lender a claim on the asset, in case if borrower fails to repay the loan at any given point in time. Loan-to-Value gives the idea to the loan applicant about the maximum percentage of the value of the collateral that he/she can borrow.
  • How LTV works: However amount of borrowing is determined on multiple factors such as eligibility of the borrower, credit score etc. but it is not limited to the value of collateral. Therefore, to determine the loan amount that can be lent to the borrower, the lending institution shall use the loan-to-value ratio to cap the final amount of loan based on the value of the pledged asset.
  • Calculation of LTV ratio: There is a simple formula that is used to determine the LTV ratio.

LTV= (Loan quantum/Appraised value of the collateral) X 100

Let us make it simple for you, if a loan seeker needs any kind of loan requiring 50 lakhs urgently and lender after evaluating the market value of the pledged asset sanctions 40 lakhs then the LTV ratio would be as follows:

LTV= (40 lakhs/50lakhs) X 100 = 80%

The loan-to-value ratio may also vary depending upon the value and the condition of the pledged asset as collateral for the loan.

  • Perspective on better LTV: If we consider the lender’s perspective, a lower LTV is better for the borrower ensuring the high level of commitment from the borrower as the interest rates and risks are high to secure the higher LTV ratio. But if see it from borrower’s perspective, and then a higher LTV is more attractive for the borrower to get the loan quickly. A higher LTV ratio may add up as burden on your finances but it may also allows you to negotiate for longer repayment period and lesser rate of interest.
  • Importance of Loan-to-Value ratio: It is an important metric that layout the lending risk a lender bears by approving a loan as per the borrower’s requirement. The evaluation of borrower’s loan proposal rate is determined by comparing the size of loan requested with the size of the pledged asset. In case of any default by the borrower, the pledged asset proceeds to be sold to cover the outstanding principal amount and accrued interest rate. Hence, it is utmost to properly analyze the aspects of Loan-to-Value ratio.


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