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Rajeev lost his job recently and his immediate worry is home loan EMI of Rs.15,000. For a person with an annual salary of Rs.3.0 lakh, this is a huge burden. He is having sleepless nights. He has cut his household budget to minimum and savings have been reduced too.
Where did Rajeev go wrong? Initially, when he approached banks for financing his house, he was offered 75% finance. He was not able to take a decision because he wanted to keep his down payment to the minimum. One day he received a call from a private bank which offered him up to 90% finance but with a higher interest rate. Without thinking twice he took the loan. What Rajeev didn’t understand at the time of application was significance of Loan To Value (LTV).
Recently RBI raised the ceiling for banks to grant home loan. On home loans above Rs.20 lakh, banks can finance only up to 80% and below Rs.20 lakh, the LTV can go up to 90%. This has not been welcomed by buyers who want to maximize their loan amount.
While applying for a loan , we do not look at LTV. What matters to most of us is how low our interest rate is? But LTV plays a major role.
Loan To Value or LTV is the ratio of loan amount to the value of property. In simple terms, it is the amount you want to borrow divided by the value of the home you want to buy (or refinance). To calculate LTV you should know approximately how much your home is worth, the amount of the mortgage you want to take and the down payment amount.
Let’s assume Rajeev wanted to buy a new constructed home with a value of Rs. 40,00,000. If it’s a resale, estimation can be done by looking at what similar properties in your neighborhood have been sold for.
Suppose Rajeev is ready to make a down payment of Rs.4,00,000. LTV is calculated by subtracting the down payment from original purchase price. In this case, Rs.36,00,000, which Rajeev wants to finance. Dividing this by the purchase price of Rs.40,00,000, we get an LTV of 90%.This is what Rajeev wanted.
Valuation of House – Who does it?
When you submit the loan application, the lenders respond to you by saying that their surveyor will come and value the house. This is the standard procedure adopted by the all lenders where the LTV is totally dependent upon the surveyor’s valuation of your house. So if the market value of your house is Rs 80 lakh but surveyor arrives at a value of only Rs 60 lakh, then you will be offered the loan based on Rs.60 lakh and not Rs.80 lakh.
Thus the value of the house will be market value or valuation arrived at by the surveyor, whichever is lower.
Why LTV is important?
The LTV ratio is often ignored by the buyer. Interest rate and term of the loan is most important criteria for buying a house. But from lender’s point of view LTV is the key factor which decides the outcome of a loan application. The lender’s decision on the application is based on this single factor.
When a lender receives an application for a home loan, the priority is to calculate the odds against it. These odds identify whether you will be granted the loan or not. Meeting regular payment of loan, managing your total current debts and the loan you have applied for and sustaining income in the long term are the deciding factors. Once the odds are identified, the same is reflected in the terms and conditions and the lender determines whether the applicant is a good risk or not. Sometimes, if the lender perceives you to be a high risk borrower, you might be asked to increase the down payment and thereby reducing the LTV. Along with it, you may be charged a higher rate of interest.
Loan to Value ratio also reflects your credibility to the lender. The lower the LTV, the more credible you are. This means the more money you pay as down payment, the more trustworthy borrower you are for the lender. From financial planning perspective a minimum 15-20% should be your down payment. If you increase this to 25%, your chances of getting your loan approved are very high because in case of default, the lender has enough cushion for recovering their loan.
Hence, understanding loan to value ratio is very important. If your LTV is low, your equity in the house will be substantially higher and the worth will be more than what you have paid for it. This equity can also be used to borrow additional funds, refinance the mortgage or even shorten the mortgage loan.