As one of our favorite holidays draws near, most Americans are excited to spend time with family, travel, and of course enjoy the inevitable feast and their favorite traditions. Since all of us at rateGenius are American (we all live in the Austin, Texas area), we're excited, too. What makes us unique, however, is that…
Many terms and acronyms may be thrown around during the loan approval process, especially when refinancing. Unless you’re well-versed in personal finance and banking, you may not fully understand the information you receive. In order to be a more informed and conscious consumer, it’s important to know what some of those terms mean. One of the most commonly question acronyms is “LTV”, or loan-to-value ratio.
LTV is a number that compares the value of the asset to the loan that it secures. Put another way, when you purchase a car, your lender issues a loan plus interest to help you make the deal. Technically, because your lender issued the funds to purchase the car, that car is collateral in the event that you default on your payments. So, LTV is the ratio that determines the level to which the asset will pay off the loan.
A more common phrase associated with LTV is being “upside down.” When a borrower is “upside down,” it means that they owe more than what the car is worth. People who are “upside down” have a high LTV.
So, why is LTV important?
LTV is an assessment of risk. Lenders are notorious for favoring less “risky” applicants for loans. They assess a number of criteria (credit score, LTV, DTI, and others) to determine the likelihood that each person will make their payments, on time, for the duration of the loan. After all, lenders want to get not just their money back, but also the interest rate on top of that.
LTV determines risk because in the event that the borrower defaults, it determines the return on the loan that the collateral’s value would provide. A higher LTV means that the asset is less likely to pay off the loan, and that’s why higher LTVs are less likely to be approved for refinancing.
I might have a high LTV. Am I doomed?
You’re not doomed. A high LTV will make your loan application less appealing for lenders, but isn’t guaranteed that you’ll be denied. Instead, your lender may give you a higher interest rate or add certain stipulations onto your loan in order to mitigate risk.
There’s more to the story
Though LTV ratios are an important component in lender decisioning, it’s not the only piece to the puzzle. Offers are typically based on the combination of several factors, so even if you have a high LTV you could still be eligible for refinancing.
We always advise customers that the earlier you refinance your current loan, the better. Because cars lose value relatively quickly, the sooner you refinance, the less likely you are to have a higher LTV ratio.