What is a loan-to-value ratio and how does it work?

When you’re applying for a mortgage, the numbers matter. So it’s important to understand what everything means, which isn’t always easy when you’re trying to decipher industry jargon and acronyms.

One of these terms is “loan-to-value ratio”, which is often simply referred to as LTV. When applying for a home loan, the LTV can make a big difference in what type of mortgage you’re eligible for, your loan’s interest rate and the fees you pay.

Below, CNBC Select covers how loan-to-value ratios work and why it’s such an important number to understand.

A loan-to-value ratio (LTV) is a number that shows how much money is being borrowed in comparison to the value of the collateral. LTV has significant implications for mortgage applications and is expressed as a percentage. For example, if you’re purchasing a home worth $100,000 and your mortgage loan balance is $80,000, you have an 80% LTV.

The LTV requirement for a mortgage depends on the type of loan and your financial situation. If you’re struggling to find a home loan that fits your needs, try a lender that offers a larger variety of loan types. PNC Bank is CNBC Select’s best mortgage lender for flexible loan options and offers conventional loans, USDA loans, VA loans, FHA loans and more.

Calculating LTV is straightforward because you’ll typically only have to know two numbers: The loan amount and the appraised property value.

The formula is this:

Current loan balance / current property value = LTV

You can change your initial LTV by increasing your down payment or negotiating a lower purchase price. Over time, your LTV will drop as you pay off the loan and the property (hopefully) increases in value.

LTV vs. CLTV

Whenever you’re taking out a second loan on a property the lender will look at a combined-loan-to-value ratio (CLTV). The CLTV uses a similar formula as LTV but factors in the balances of multiple loans.

A common situation where CLTV matters is when you’re getting a home equity loan or a home equity line of credit (HELOC). For these types of loans, you’re typically allowed to have a CLTV of up to 80%.

If you’re looking to cash out some of your home’s equity to pay for a renovation, calculating your CLTV helps you figure out your rehab budget. Let’s say your home is worth $350,000, you’ll usually be able to borrow up to an 80% CLTV, which would be $280,000 in total. This means if your current mortgage balance is $200,000, you could finance $80,000 in home upgrades.

When it comes to mortgages, LTV affects what type of loans you’re eligible for and your borrowing costs.

The LTV requirements for a mortgage vary depending on the loan type. Mortgages with smaller down payment requirements, for example, allow for higher LTVs. An FHA loan allows down payments of as little as 3.5% or an LTV of 96.5%. And USDA or VA loans can have an LTV of 100% (essentially requiring no down payment).

Conventional loans usually have stricter LTV guidelines, although certain conventional loan programs allow for an LTV as high as 97%. Just remember that with conventional loans, you’ll be required to pay private mortgage insurance (PMI) if your LTV is 80% or higher.

Aside from helping you qualify for a mortgage, a lower LTV can get you a better interest rate, although other factors such as your credit score, the type of loan and the loan balance also play a role.