What does the term "loan-to-value ratio" refer to?

The term "loan-to-value ratio" specifically refers to the percentage of a property's value that is financed through a mortgage. It is a critical measure used by lenders to assess the risk associated with lending money for a property purchase. The ratio is calculated by dividing the loan amount by the appraised value of the property. For example, if a borrower seeks a $200,000 mortgage on a home appraised at $250,000, the loan-to-value ratio would be 80% (200,000 ÷ 250,000 = 0.8 or 80%).

This ratio is important because it helps lenders determine how much equity the borrower has in the property and the likelihood of default. A lower loan-to-value ratio generally indicates more equity and less risk for the lender, while a higher ratio could signify greater risk, potentially leading to higher interest rates or the requirement for private mortgage insurance (PMI).

Understanding loan-to-value ratios is essential for both lenders and borrowers, as it directly impacts loan approval, terms, and overall cost of borrowing.