The CLTV ratio is determined by dividing a property's total amount of secured loans by its market value. Lenders use the CLTV ratio as a proxy for the risk of default in a multiple loan transaction.

Because Fannie Mae and Freddie Mac won't buy mortgages with LTVs above 80%, most lenders cap LTVs there. Borrowers with perfect credit scores do not need to pay for private mortgage insurance, but borrowers whose primary loan amounts are greater than 80% of the value of their home do (PMI). Private mortgage insurance (PMI) can help cover the lender's loss if the property's appraised value drops below the loan amount.

Using the CLTV Ratio

The combined loan-to-value ratio (CLTV) is a common metric used by mortgage and lending professionals to determine what percentage of a home's value is covered by all loans and mortgages on the property (debt obligations). Lenders use several metrics, such as the conventional loan to value (LTV) ratio, debt to income ratio, and CLTV ratio, to determine if extending credit to a borrower is worthwhile.

Many economists believe that lenient CLTV requirements contributed to the foreclosure crisis that hit the United States in the late aughts. Beginning in the 1990s, homebuyers increasingly resorted to second mortgages in place of traditional down payments in the early and mid-2000s. Lenders accepted the increased risk of retaining these customers and not losing them to competitors.

A twenty percent down payment was standard practice before the housing market bubble of the late 1990s and early 2000s. They helped keep borrowers in check because their typical loan-to-value (LTV) ratio was 80%.

As the bubble heated up, many of these same businesses changed their policies to no longer require a 20% down payment. While some banks have raised their LTV limits to 100%, others have kept their LTV requirements the same while raising their CLTV limits, often to 100%, making mortgages available with down payments of 5% or less. By employing this tactic, buyers could use second mortgages to cover the 20% down payment required by most lenders.

Where does CLTV fit into the picture?

Borrowers sometimes get second mortgages to cut down on the total amount they have on a home. With a lower loan-to-value (LTV) ratio, many homebuyers can forego private mortgage insurance (PMI) (PMI). Borrowers must weigh the benefits and drawbacks of second mortgages and private mortgage insurance (PMI) to determine the best for their unique situation.

Second mortgages typically have a higher interest rate than first mortgages due to the increased risk the second mortgagor takes. Consumers should carefully weigh the benefits and drawbacks of multiple loans on the same property. Doing one's "due diligence" entails investigating all viable options in depth to identify the one most suited to a given circumstance.

A Look at the Difference Between LTV and CLTV

The loan-to-value (LTV) and combined loan-to-value (CLTV) ratios are two key metrics utilized by mortgage underwriters. The loan application will be denied if either number exceeds the lender's threshold. The LTV ratio considers only the primary mortgage. By dividing the mortgage loan balance (here, $100,000) by the property's estimated market value ($200,000), we get the loan-to-value (LTV) ratio.

Most lenders set their LTV limits at 80% because Fannie Mae and Freddie Mac won't purchase mortgages with LTVs above that amount. Private mortgage insurance is not required for borrowers with excellent credit, but it is necessary for those whose primary loan amounts are greater than 80% of the value of their home (PMI). Private mortgage insurance (PMI) helps cover the lender's loss if the property's appraised value declines below the loan amount.

Primary lenders typically have more lenient CLTV requirements. A second mortgage holder would not receive any funds until the first mortgage holder was repaid in full. Before the borrower defaults, if the collateral's value drops from $150,000 to $125,000, the first lienholder would collect the full $100,000 owed, and the second lienholder would collect only $25,000 despite being owed $50,000. With a higher CLTV, the primary lienholder incurs less risk in the event of a decline in property value.

A Primer on Business Accounting and Finance

Over 183,000 online video courses make it simple for anyone to study business accounting and finance from their home. Udemy is a fantastic place to acquire a working knowledge of business terminology, with classes covering everything from how to read financial statements to conducting in-depth business analyses. A 30-day money-back guarantee is included, and new content is added to the courses monthly. Learn more about Udemy and sign up right away.