Understanding the Concept of an LTV

When you Apply for a Loan Against Property(LAP) or a Home Loan, you frequently come across the term ‘Loan to Value ratio’ (LTV ratio). What do you understand by LTV?

Loan to Value Concept

LTV in simple terms is the ratio of the quantum of the loan to the value of the property. The ideal LTV is 75%. It means that the loan amount is equal to 75% of the value of the property. In today’s competitive banking industry, banks approve Home Loans up to 90% of the value of the property as well.

The Reserve Bank of India (RBI) has stipulated that banks can finance up to 90% of the property value if the loan is up to 30 Lakhs. Over 30 Lakhs, the LTV ratio is 75%.

What Does it Signify to the Borrower?

The borrower has to bring in the margin towards the Home Loan. When the LTV is 90%,the borrowers have to bring in a minimum of 10% as their share. Similarly, for loans above 30 Lakhs, the borrower’s share is a minimum of 25% of the value of the property.

LTV Ratios Differ from Product to Product

A Home Loan has LTV in the range of 75% to 90%. Similarly, a Loan Against Property attracts an LTV ratio of 40% to 90%. Why do you have a difference in the LTV ratios in a Home Loan and a LAP? The reason is simple. A LAP is a secured Personal Loan against the collateral of property whereas you create an asset when you take a Home Loan. The purpose of a Home Loan is adefinite one whereas you need not disclose the end use of funds when you avail a LAP.

People in India have a sentimental value attached to the Home Loan. The chances of default in a Home Loan are less when compared to a LAP. Therefore, banks prescribe a higher margin (lower LTV ratio) for a LAP.

Is the LTV Concept Restricted to Home Loans and Mortgage Loans Alone?

No, the LTV concept is applicable on all loans that have the backing or support of an asset. In the case of a Home Loan or a LAP, the collateral is the house. Similarly, in a car loan, the underlying asset is the car. Banks stipulate LTV ratio in the range of 75% to 85% of the value of the vehicle.

Therefore, we can say that the LTV ratio is the proportion of the loan to the value of the underlying asset. In the case of loans against FD receipts, the LTV ratio is up to90%. Similarly, loans against NSC and KVP attract an LTV ratio of 75%.

Other Areas Where the LTV has a Bearing

LTV is an important concept. It determines the extent up to which a bank can finance a borrower. It is also a signal to the borrower that they have to bring in the minimum amount of margin depending on the LTV ratio. Thus, if the LTV ratio is 75%, the minimum margin brought in by the borrower is 25%.

LTV ratio has an important role to play in determining the risk-weighted assets for the bank. The risk-weighted assets play a vital contribution to the maintenance of the Capital Adequacy Ratio of the bank. It also plays a role in the bank determining its Marginal Cost of Funds Based Lending Rate (MCLR). Banks have to report the risk-weighted assets every quarter. Every asset of the bank has a risk weight. When we say every asset, we mean ‘every asset.’ It includes loans, furniture, properties in bank’s name, guarantees and letters of credit issued by the bank and still outstanding in the books, and so on. The LTV plays a crucial role in calculating the risk-weighted assets percentage. The higher the LTV, the lower is the risk weight.

This example can simplify matters. Personal Loans do not have any collateral. Hence, they are unsecured loans. Therefore, the LTV is 0%. They attract the maximum risk weight. Similarly, the Home Loans have the highest LTV ratio in the industry. Consequently, they have the lowest risk weight.

The proportion of risk-weighted assets indirectly affects the customer. We have seen that the risk-weighted assets percentage affects the MCLR. A higher risk-weighted asset figure entails a higher MCLR. It automatically affects your Home Loan interest rates and all the other floating rate of interest loans. Hence, having a higher LTV is beneficial to the bank because it reduces the proportion of risk-weighted assets.

With the banks surging forward to maintaining the Capital to Risk (Weighted) Assets Ratio (CRAR) at 10.5% as per Basel III norms, the concept of LTV is gaining importance.