How to calculate loan-to-value ratio, step by step
The loan-to-value ratio is one division that answers one question: what share of the home does the loan cover? A buyer who knows the answer can see how much of the home is borrowed and how much is owned outright from day one. The calculation is the loan amount divided by the property value — two numbers from any mortgage, divided. The answer is a percent: a ratio of 80.00% means 80 cents of every home-value dollar is borrowed, and the rest is owned outright.
The formula is loan-to-value ratio = loan amount ÷ property value. The loan amount is what you borrow from the lender — the mortgage itself. The property value is what the home is worth — the purchase price, or the appraised value if the lender uses that instead. Both figures are in the same currency, on the same home, or the ratio is wrong before it starts.
The worked example, line by line. Step 1 — the loan amount: $320,000. Step 2 — the property value: $400,000. Step 3 — the division: $320,000.00 ÷ $400,000.00 = 80.00%. Step 4 — the down payment: $400,000.00 − $320,000.00 = $80,000.00. Step 5 — the meaning: 80 cents of every home-value dollar is borrowed. As a decimal the same ratio is 0.8000 — the percent and the decimal are two ways of writing the same number, never the same figure: 80.00% is the share, 0.8000 is the fraction. Work it yourself in the loan-to-value calculator.
What the number means
A ratio of 80.00% means 80 cents of every home-value dollar is borrowed, so the loan covers four-fifths of the home and you own one-fifth outright. A lower ratio means less borrowing: the loan covers less of the home, and a fall in value still leaves you with equity. A higher ratio means more borrowing: the loan covers more of the home, and a fall in value can leave you owing more than the home is worth. The ratio on its own never says whether 80.00% is comfortable or tight — that depends on the lender and on how steady your income is. A buyer with steady income can run at a higher ratio because the payments are easy to service, and a buyer with lumpy income can struggle at the same ratio. What the ratio does say, plainly, is how much of the home the loan covers.
What moves the loan-to-value ratio
Two things move the ratio: the loan and the value. Raise the loan amount and the ratio rises, because a bigger loan covers more of the same home: with the value held at $400,000, a loan of $200,000 puts the ratio at 50.00%, and a loan of $360,000 puts it at 90.00% — the smallest loan for the ratio to reach 90% is $360,000. Cut the loan — a bigger down payment — and the ratio falls. Raise the property value and the ratio falls, because the same loan is now a smaller share of a bigger home: the same $320,000 of loan against $500,000 of property value is a ratio of only 64.00%. Cut the value — a falling market — and the ratio rises, because the same loan is now a bigger share of a smaller home.
The 80% line and PMI
Most conventional lenders draw the line at 80%: above 80% they usually require private mortgage insurance — PMI — a monthly premium that protects the lender, not you, until the ratio falls back to 80% or below. At 80% or below it usually drops off. That is why the 80.00% worked example matters: $320,000 of loan against $400,000 of property value sits exactly on the line. Borrow a dollar more and the ratio is above 80% and PMI applies; pay a dollar more down and the ratio is below 80% and PMI drops off. Work out the premium itself in the PMI calculator, and when it drops off in the guide to calculating PMI.
When the ratio is undefined
If the loan amount and the property value are both $0, the ratio is undefined — the property value is $0, and dividing by $0 has no answer. A home with no value at all has no ratio to calculate, only a warning. If the loan amount is $0, the ratio is 0.00% — a real figure, not undefined: nothing of the home is borrowed. If the property value is $0 while the loan is not, the ratio is undefined too — there is nothing to divide by, so there is no share to report.
Common mistakes
The first mistake is confusing this ratio with the down payment — that one is the property value minus the loan amount, the cash you put in, not the share the loan covers. The same $320,000 of loan and $400,000 of property value give a down payment of $80,000.00, and mixing the two up turns dollars into a percent. The second is confusing it with the monthly payment — that one is what you pay the lender each month, principal and interest over the term, not the share of the home the loan covers. The third is using the wrong value — the loan divided by the purchase price is not the same as the loan divided by the appraised value when the two differ, and the lender uses the lower of the two. The fourth is forgetting the ratio moves — a falling home value pushes the ratio up without a dollar of loan being added. Work it out in the loan-to-value calculator, and check the PMI calculator and the down payment calculator before you decide what the loan means.