A loan-to-value ratio compares your loan amount to the value of the asset (a vehicle, for example) used to secure the loan.
Auto lenders use this ratio to assess the risk of the loan for which you may be applying, and this can have a large impact on what your insurance rates may be and your monthly payments.
Your loan-to-value (LTV) ratio is typically assessed alongside your credit score when you initially apply for a loan. The lower your LTV ratio, the better!
Continue reading to learn more about loan-to-value ratios, how to calculate your own, and what your ratio may mean for you.
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What is a loan-to-value ratio?
An LTV ratio is the amount of your
car loandivided by the value of your asset, which—in this case—is your vehicle.
The ratio is expressed as a percentage and notes how much of the loan is backed up by real-world value.
How to calculate your loan-to-value ratio
Once you know the equation for calculating your LTV, then finding your ratio should be simple!
Your LTV = Loan Amount ÷ Car Value
For example, if you borrow $15,000 to purchase a $15,000 vehicle, your LTV will be 100% (100% = $15,000/$15,000).
But if you had to borrow $25,000 for a $20,000 car, then your LTV would be 125% (125% = $25,000/$20,000).
LTV ratio requirements will differ depending on your loan, but you should ideally aim for no more than 80%.
Why your loan-to-value ratio is important
If you have a higher loan-to-value ratio, it can mean the following:
- You might get denied for refinancing
- You can see higher interest rates
- You’ll have higher monthly payments
- You could end up with less equity in your asset
If you have a lower loan-to-value ratio, then it can benefit you in the following ways:
- You could receive better interest rates
- You’ll have lower monthly payments
- You can build more equity in your asset
How to lower your loan-to-value ratio
There are a few ways to lower your loan-to-value ratio, which can ultimately help you save money on your car.
You can start by borrowing less money initially. If you don’t have enough money to make a larger downpayment, then it might be worth waiting a bit and saving up before diving into an auto loan.
Increasing your monthly payments and working to pay your loan off more swiftly can also help to lower your LTV ratio.
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If you are stuck with a high loan-to-value ratio and have hiked interest rates as a result, then you might want to look for other ways to save—like on car insurance.
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What happens if my loan-to-value ratio is over 100%?
While nothing drastic will happen if your LTV is over 100%, it can lead to higher interest rates and higher monthly payments.
You should aim for an LTV under 80% to save more money on your auto loan.
Why do lenders bother to calculate loan-to-value ratios?
Whenever a lender loans out money, they are taking a risk as to whether or not the borrower will be able to pay them back.
One of the ways that lenders can protect themselves is to set maximum loan-to-value ratios.
By doing so, they can vet out borrowers that might be financially unstable or untrustworthy, lowering the risk they take when loaning out money.