Loan to Value Ratio: Know Why is Important for Investors

Loan-to-value or LTV ratio is the amount of loan you can borrow against the total market value of the property. Generally, the LTV ranges between 70% to 90% of the value of the property, and it also depends on the type of loan availed and the borrower’s relationship with the lender.A higher LTV signifies a higher loan amount, which in turn would mean that you must make lesser down-payment. However, on the flipside, higher loan would mean higher EMI, and vice-versa. LTV plays a significant role in mortgage investing. Before we delve into who LTV applies to mortgage investing, let us first understand how mortgage investing works.

Investors in real estate who invest in various properties seek a mortgage loan, which is essentially a promissory note by keeping the property they wish to purchase as a collateral with the lender. Financial organisations sell mortgage notes to free their cash flow. Buying a mortgage note is an excellent investment for people who wish to invest in real estate properties without having the hassles of being an owner of the property.

The Loan-to-value ratio signifies the size of the loan against the value of the property. It represents the percentage of ownership that the owner has in the property. When the investor purchases a mortgage note, the LTV ratio is determined by dividing the amount of the mortgage by the value of the property.For example, if the value of the property is Rs, 100,000 and the loan availed against the property is Rs. 60,000, then the LTV ratio is 60%.If the LTV ratio is high, it carries higher risk for the investor because the borrower has less equity in the property and the chances are high that they may default on the payments. A mortgage note with a lower LTV is much safer as the note holder has better chances of recouping their investment if the borrower defaults. Generally, experts suggest that a LTV ratio of 80% or more is considered as high-risk for investment.

Before delving into how you can avoid underwater mortgage, you must first understand what an underwater mortgage is.An underwater mortgage is a type of loan wherein the principal amount borrowed is higher than the actual value of the property. It usually happens when the property value is declining. In such a situation, the investors may not have enough equity to avail the credit.So, how to avoid the underwater mortgage? The following tips can help the investors:First and foremost, to avoid underwater mortgage, the investors must buy property below its intrinsic value. Investors must be wise and look to buy a property that is located in an area where it has a history of capital growth.Several experts around the world have corroborated that following the 1% rule can be highly effective in avoiding underwater mortgage. Investors must focus on investing in properties that will rent 1% of the purchase price every month.Another significant way to avoid underwater mortgage is to invest in the A-class areas, which are known to have high quality infrastructure facilities with better neighbourhoods as it helps to negate the negative effect of the market crash.Investors can keep the value of the properties that they have invested in by doing a regular assessment of property for damages or any signs of danger. People who neglect the safety aspect of the property, and if anything untoward happens, there is a high risk that the investor may face legal charges against them, which in turn would have a significant impact on the property value. Regular assessment can help investors to identify the potential dangers and take immediate corrective action.Just as any investment, real-estate investments also carry a certain degree of risk. Hence, it is paramount that investors have a financial buffer just in case things go haywire. The financial buffer can help investors protect from the rising interest rate, and the best way to mitigate the increased interest rate is to establish a credit line.So, to sum it up, investors who take their rental property business seriously, they can avoid the risks of the underwater mortgage even in the volatile economic conditions. Just like any other business, the key is to have a good risk-management strategy in place.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.