Loan-To-Value Ratio - LTV Ratio

What is The Loan To Value Ratio (LTV)?

This is the value of your house: 400 grand. This is your down payment: 100 grand. And this is your Loan: 300 grand.

Loan
To
Value

It’s a fraction. Easy. 300 grand, over 400 grand.

That's 3 over 4. Or 75 percent.

What does that mean? Like why do we even care about an LTV ratio? Because it speaks volumes as to how risky the loan is to the bank, or whoever is lending the dough in this transaction. So you want a low loan-to-value ratio if you’re the lender, because the worst thing that happens is that you repossess whatever the asset was that was pledged as collateral against the loan, and sell it to somebody else.

So this equation works great with homes, because over time, homes generally go up in value, not down. But how does this work when you take out a car loan? Cars are almost never an investment - they’re just a money pit. So you really wanted that $42,000 convertible Prius with the turbo-charging battery, which gave it a 0-60 rating of 7.8 seconds, rather than the standard Prius rating of just, yes.

The problem? You put $10,000 down and borrowed $32,000 on what you hoped would be a five-year loan. Unfortunately, six months after you drove off the lot, the market value of your turbo Prius is only something like $30,000, maybe less. And in that time period, you’ve only paid $4,000 of principal paydown of your loan.

So you still owe $28,000 on an asset that would sell for 30 and after commissions, transaction costs, and hassle, would certainly be worth less than that money to whoever had to repossess and then sell it. Cars suffer this very difficult LTV equation all the time, and it is part of the reason that car loans are so expensive when you put down only a modest amount of dough up front.

So the big idea: high LTV’s are bad, low LTV’s are good. When in doubt, uh...go turbo.