What formula is used to calculate the loan to value (LTV) ratio?

The loan to value (LTV) ratio is a critical financial metric often used in real estate to assess the risk associated with a mortgage. It is calculated by dividing the amount of the loan by the sale price or appraised value of the property. This gives lenders an idea of how much of the property's value is being financed and reflects the borrower's equity in the property.

The reason this calculation is important is that a higher LTV ratio indicates higher risk; it means the homeowner has less equity and the lender has more financial exposure. Conversely, a lower LTV suggests that the borrower has a greater stake in the property and minimizes risk for the lender.

In this context, using the loan amount divided by the sale price or appraised value accurately reflects the relationship between the loan and the property's worth, which is essential in underwriting decisions for loans and in evaluating the overall market health.