Loan Against Property: Understanding the Concept of an LTV

While applying for a loan against property, you might stumble across the term "Loan to Value ratio" (LTV ratio) quite often. However, most people do not understand the concept of LTV. It is essential to learn the details of the LTV ratio as it determines the extent up to which lenders can finance a borrower.

In simple terms, LTV is the ratio of quantum of the loan to the value of the property. The ideal LTV is 75%, i.e., the approved loan amount is equal to 75% of the total value of the property. Due to the ing competition, some lenders finance up to 90% of the property value, if the loan is up to Rs. 30 lakhs.

The LTV ratio differs from one product to another. For home loans, LTV is in the range of 75% to 90%. Whereas, in case of a loan against property, LTV ratio can be anywhere between 40% to 90% depending upon the loan amount. Most people believe that the LTV concept is applicable just for home loans or Loan Against Property. However, this is not true. LTV is calculated on all loans that are pledged against an asset. In the case of a Home Loan or (LAP) Loan Against Property, the collateral is the house. Similarly, in a car loan, the basic asset is the car. Most loan providers stipulate LTV ratio in the range of 75% to 85% of the value of the vehicle. Therefore, the LTV ratio is the proportion of the loan to the value of the underlying asset. In the case of loans against Fixed Deposits, the LTV ratio is up to 90%.

Banks and other financial institutions determine the risk-weighted assets with the help of the LTV ratio. This helps in maintaining the Capital Adequacy Ratio of the bank. Moreover, it also plays a role in determining the Marginal Cost of Funds Based Lending Rate (MCLR) of the financial institutions. Every asset of the financial institutions has a risk weight. The assets mainly include loans, furniture, properties in the bank’s name, guarantees and letters of credit issued by the bank, etc. The LTV also helps in calculating the risk-weighted assets percentage. For higher LTV, the risk weight is comparatively lower.

Since a personal loan is an unsecured loan and does not have any collateral, the LTV associated with it is 0%. Therefore, they have the maximum risk weight. On the other hand, home loans have the highest LTV ratio in the industry. Thus, they have the lowest risk weight. Having a higher LTV is beneficial to the bank as it reduces the proportion of risk-weighted assets.

A higher risk-weighted asset figure brings about a higher MCLR. This automatically affects the home loan interest rates and all the other floating interest rate loans.

In order to follow the Basel III norms, banks and financial institutions strive to maintain the Capital to Risk Asset Ratio (CRAR) to 10.5 %. As a result of this, the concept of LTV has gained much popularity in recent times.

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