What is loan-to-value (LTV) and how it affects your loan?

In personal finance, loan-to-value or LTV is a significant metric that is used by lenders to evaluate the size of the loan against the estimated fair market value of the asset being placed as collateral with the financial institution. Primarily, it helps assess the risk associated with the secured loan and helps determine the prospective borrower’s chances of loan approval, down payment amount, and interest rate.

LTV is calculated on the basis of the formula specified below:

LTV = (loan amount/ fair market value of the asset placed as collateral) x 100

For instance, if a bank approves a home loan of ₹60 lakh against a property valued at ₹1 crore, the LTV comes to be 60%

From approval of the loan to final interest rate determination, LTV heavily influences the entire process and is a crucial risk assessment metric.

Approval chances: When it comes to loan approval and sanction, lenders show preference for lower LTV ratios ranging between 70-80% as a higher LTV would otherwise signify that a bank is financing a large chunk of the asset. This then can reduce your loan approval chances or call for stringent terms such as higher interest rate, eligibility check etc.

Down payment: In a case if the bank allows for a 80% LTV, the remaining 20% has to be serviced by you as a down payment.

Interest rate: On a lower LTV (say 60-70%), banks generally offer an attractive low interest rate. In contrast, a loan carrying the maximum LTV - taking into account a higher risk - may be offered at a slightly higher rate.

RBI rules on LTV for different secured loans in India

The Reserve Bank of India (RBI) has provided for specific LTV ratios for different secured loans available in the country. These limits are set to manage and mitigate financial risk as well as protect borrowers.

Gold loans: Gold loans sanctioned on and after April 1, 2021 will qualify for a maximum LTV ratio of 75%, meaning maximum loan amount that can be sanctioned against gold ornaments etc. shall be up to 75% of the gold value. During Covid, RBI increased the limit to 90% to offset the economic impact due to the crisis.

Silver-backed loans: The maximum LTV ratio can be 85% for a loan amount of up to ₹2.5 lakh, while it has to be 80% for loan amount between ₹2.5 lakh and ₹5 lakh, and 75% above 5 lakh.

Home loan LTV ratios as specified by RBI: