In a typical mortgage loan, what does the term 'loan-to-value ratio' refer to?

The term 'loan-to-value ratio' refers to the proportion of the loan compared to the appraised property value. Specifically, it is a financial term used by lenders to assess the risk of granting a mortgage. The ratio is calculated by dividing the amount of the mortgage loan by the appraised value (or purchase price, whichever is lower) of the property.

For instance, if a buyer wants to purchase a home valued at $200,000 and they take out a mortgage for $160,000, the loan-to-value ratio would be 80%. Lenders often use this ratio to determine how much of a down payment is made and to assess whether the borrower poses a higher risk, as a higher ratio indicates less equity in the property, which might increase the chance of default. Therefore, a lower loan-to-value ratio generally indicates a lower risk for lenders, while a higher ratio may result in the borrower having to pay private mortgage insurance (PMI) or face higher interest rates.

Understanding this concept is crucial for anyone involved in real estate, as it directly impacts loan approvals and terms.