What is Combined Loan-To-Value Ratio — CLTV Ratio
The ratio of all secured loans on a property to the value of a property is the combined loan-to-value (CLTV ratio). When more than one loan is used, the CLTV ratio is used by lenders to identify a prospective home buyer’s risk of default.
To borrowers with high credit ratings the lenders are willing to lend at CLTV ratios of 80% and above.
The CLTV differs from the simple loan to value (LTV) ratio where the LTV includes only the initial or primary mortgage in its calculation.
The calculations and formula of CLTV
CLTV = value of loan 1 +value of loan 2 + (Any further value on loan) / Total value of the property.
When we divide the aggregate principal balances of all our loans by the property’s purchase price we get the calculation of the combined loan-to-value ratio.
The CLTV ratio is thus inferred by the division of the sum of various things (listed below) by the appraised value of the property.
- The first mortgage’s original loan amount.
- The remaining principal balance of a home equity line of credit
The outstanding principal balance of all closed-end subordinate financing like the second or third mortgage (a borrower draws down all funds on day one and may not change any payment plan or once the loan is closed may not access any paid-down principal with a closed-end loan.)
What does the CLTV ratio show?
The mortgage and lending professionals use the combined loan to value (CLTV) ratio to decide the total percentage of a homeowner’s property that is stalled due to debt obligations.
Along with a few other calculations, like the debt to income ratio and the standard loan to value (LTV) ratio the lenders use the CLTV ratio, to gauge the risk of giving a loan to a borrower.
Among various other factors, many economists feel that a relaxed CLTV standard led to the foreclosure crisis in the United States during the late 2000s.
Homebuyers frequently took out second mortgages at the time of purchase in lieu of making down payments at the beginning of the 1990s and the early and mid-2000s.
Greed lenders unwilling to lose these customers’ business to competitors agreed to such terms and the risks increased leading to the housing crisis.
The standard practice before the real estate bubble that filled the period from the late 1990s to the mid-2000s, was for homebuyers to make down payments adding up to at least 20% of the purchase price.
Most customers were kept within these parameters by the lender who capped LTV at 80%.
When the bubble began flaring up, many of these companies took action to allow customers to get around putting 20% down.
The LTV caps were raised by some lenders and offered mortgages with 5% down payments or less, while others kept LTV requirements in place but raised CLTV caps, to 100%. This action lets customers take out second mortgages and finance their 20% down payments.
The foreclosure spike in 2008 emphasized the importance of CLTV. Like for a $500,000 house, an initial payment of $100,000, will make the homeowner keep paying his mortgage payments.
Because if the bank forecloses, the homeowner will lose his home along with the pile of cash he paid to close.
Good equity in the property also pads up the lenders in case of a drop in real estate prices.
If the value of the property is $500,000 and the whole liens add up to $400,000, the property can drop up to 20% of its value without any lien holders receiving a short fee at a foreclosure auction.
Why is CLTV important?
When some home buyers receiving multiple mortgages on a property to lower their down payment it results in a lower loan-to-value ratio for the primary mortgage.
Because their LTV ratio is low, many home buyers are able to avoid private mortgage insurance (PMI). It depends on the individual if it is better to obtain a second mortgage or to pay for PMI.
The interest rate on a second mortgage is higher than the interest rate on a first mortgage because the second mortgagor assumes more risk.
A consumer must always look at the advantages and disadvantages of accepting multiple loans on one property and chose the best option as per their situation.
Difference between a loan-to-value and CLTV
Two of the most common ratios used during the mortgage underwriting process are LTV and CLTV.
Most lenders demand a maximum on both values, above which the borrower is not eligible for a loan. As we mentioned earlier the LTV ratio considers only the primary mortgage balance.
As Fannie Mae and Freddie Mac do not purchase mortgages with higher LTV ratios most lenders impose LTV maximums of 80%.
Borrowers with good credit profiles can get leverage on this requirement, but they are required to pay private mortgage insurance (PMI) till the time their primary loan balance is above 80% of the home’s value.
When a home’s value falls below the loan balance or in case the borrower defaults PMI cushions the lender from losses.
Conclusion
CLTV includes all mortgages or liens unlike LTV, which is just for the first mortgage. Lenders look at the CLTV ratio to identify if a homebuyer can afford to purchase a home.
The real estate bubble of 2008–2009 has led to the need to keep an eye on the CLTV ratio.
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