For lenders, extending mortgages is a risk calculus. The riskier it seems that a homebuyer will repay their mortgage in a timely manner, the higher the rate the bank will offer. Meanwhile, for applicants appearing to be safer bets, banks extend more attractive terms.
One of the top-level measures lenders use to determine the risk factor of any applicant is the loan-to-value ratio. This calculation determines what share of the home’s value will be mortgaged, by dividing the requested loan amount by the home’s appraised value.
Take the example of a home appraised at $250,000. If you make a $25,000 down payment, the requested mortgage will be $225,000. Divide that by the $250,000 appraised value and you get a loan-to-value ratio, or LTV, of 90%. If instead you put down $50,000, the mortgage drops to $200,000 and with it, the LTV to 80%.
Lower LTV ratios will garner better rates, within certain tiers. For instance, 80% is the standard threshold at which almost all lenders will offer a lower APY. That’s not to say you can’t get a mortgage with a 90% or higher loan-to-value. FHA loans, for instance, are generally only provided for LTVs of at least 90%.
But while 80% is a worthy goal for any homebuyer aiming to get their best deal, dropping the ratio even lower can earn you still better rates. Most lenders will lower their rates at every 5% or 10% LTV mark, so putting enough money down to achieve a 75% or 70% loan-to-value ratio will reward you with a lower APY. There is a limit, though, with lenders typically stopping the rate drops after reaching a 60% LTV.
Once you know the home’s appraised value, understanding loan-to-value ratios enables you to target your down payment to secure the best mortgage rate available.