If you're in the process of applying for a mortgage and have multiple mortgages on your home, you may have come across the acronym CLTV, which stands for combined loan to value. But what exactly is CLTV and why does it matter for your mortgage application? In this article, we'll delve into the meaning of CLTV and explore its significance in the mortgage process.
What is Combined Loan to Value?
To grasp the concept of CLTV, it's essential to first understand loan-to-value (LTV). LTV is a crucial factor that lenders consider when assessing the risk of loss in case of foreclosure. It is calculated by dividing the final loan amount of your primary mortgage by the value of your home and multiplying the result by 100 to obtain a percentage.
For instance, if your new loan amount is $250,000 and your home is valued at $500,000, the LTV is 50%. This means that the loan amount represents 50% of your home's value. Lenders prefer lower LTV ratios for several reasons:
- The home is more likely to sell for enough in a foreclosure sale to cover the entire loan balance and related fees.
- Borrowers with significant home equity are more likely to maintain their property and keep up with payments, even during financial difficulties.
- Borrowers with substantial equity are less likely to abandon their mortgage obligations when facing financial challenges.
Mortgage offers with lower LTV ratios generally come with lower interest rates and costs compared to those with higher LTV ratios. However, while LTV considers only the balance on your primary loan, CLTV takes into account the total balances of all mortgages on your home.
How is Combined Loan-to-Value Calculated?
CLTV is similar to LTV but is applicable when you have multiple mortgages on your home. Lenders analyze CLTV as it represents the collective loan-to-value of all mortgages on your property. The calculation for CLTV is relatively straightforward:
(total mortgage balances / home value) * 100 = combined loan-to-valueLet's explore an example to understand this calculation better. Imagine a borrower with a home worth $400,000 who wants to refinance their primary mortgage with a new loan amount of $120,000. Additionally, they have a second mortgage with a balance of $40,000.
First, the lender calculates the LTV for the primary mortgage:
$120,000 (new primary mortgage balance) / $400,000 (home value) = 0.30 (30% LTV)In this scenario, the LTV for the new primary mortgage is 30%, meaning that the borrower will owe 30% of their home's value on that mortgage at closing.
Next, the lender calculates CLTV, taking into account the total balances of both mortgages:
$120,000 (new primary mortgage balance) + $40,000 (HELOC balance) / $400,000 (home value) = 0.40 (40% combined loan-to-value)As you can see, the combined loan-to-value includes the cumulative balances of all mortgages on the property. Calculating CLTV is relatively straightforward. However, if you prefer not to do the math yourself, you can always utilize our CLTV calculator.
Why CLTV Matters
Now that we understand CLTV, let's explore why it matters to lenders. In the example mentioned earlier, the lender offering the $120,000 loan holds the first lien position. This means that they enjoy priority repayment over the second mortgage in the event of foreclosure.
Considering that the $120,000 mortgage only accounts for 30% of the home's value, it seems like the primary mortgage holder would be adequately covered. However, lenders place importance on CLTV because they know that borrowers with limited or no equity in their homes are more likely to default on their mortgage(s) during financial hardships.
Lenders calculate the combined loan-to-value of all mortgages on a property to ensure a certain amount of equity remains after accounting for all mortgage balances. It may come as a surprise, but mortgage lenders do not want to foreclose. Their primary business is lending money, not acquiring and selling real estate.
Lenders aim to approve loans that have a high likelihood of steady interest payments over the long term. They understand that borrowers with sizable combined mortgage balances and multiple mortgage payments pose a higher risk compared to those with significant equity in their homes.
A Final Note
If you have a home equity line of credit (HELOC), the lender will also calculate HCLTV, which stands for home equity combined loan-to-value. This factor considers the potential combined loan-to-value if you were to maximize your HELOC.
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