A car’s loan-to-value ratio (LTV) is the amount you want to borrow divided by the value of the car you want to buy.
Since car loans are secured – the vehicle acts as collateral – the LTV is a way for lenders to measure how much risk they are taking in approving your loan.
You can use this formula to calculate the loan-to-value ratio, expressed as a percentage:
Loan amount / car value x 100 = LTV
So if you borrow $ 30,000 to finance a $ 35,000 car, the LTV is 86%.
How the loan will affect your car loan
Since your car acts as collateral for the loan, lenders are considering selling the car to make up for losses if you disagree with the loan. The less you borrow compared to the market value of the car, the lower the risk to the lender and the greater the benefit to you.
The loan-to-value ratio affects your loan in several ways, from the interest rate you receive to approval:
Loan Approval: To limit their risk, lenders have LTV caps on lending that differ from lender to lender. LTV can affect your ability to finance if it exceeds the lender’s limits. Keep in mind that the LTV is just one of many factors that can include your creditworthiness and on-time loan payments history that lenders will review when deciding whether to approve your loan.
Lower rate: Because lenders use the LTV to measure the risk associated with your credit, a lower LTV indicates lower risk and usually results in a lower loan rate, saving you money over the life of the loan.
Deposit: As you borrow more, you reduce your LTV – improving your chances of getting a loan approval and a lower interest rate.
Negative equity: Some lenders allow you to borrow an amount in excess of the suggested retail price of a new car or the market value of a used car, resulting in negative equity. You will owe more than the car is worth, which is not ideal.
How a Car Loan Can Outperform LTV 100%
If you borrow $ 20,000 to buy a $ 20,000 car, your LTV is 100%. However, if you factor sales tax, title and license fees into the amount you borrow, you are now over 100%. Many lenders allow an LTV of 125% or more.
Another common way people end up on a high LTV is with an existing loan that they owe more than a car is worth, and the negative equity goes into the new loan. So if you buy a $ 25,000 car and owe $ 5,000 on your previous loan, you could get the full $ 30,000 for a 120% LTV.
New cars tend to lose value quickly, often by more than 20% in the first year, so buying a car with a high LTV makes it difficult to get out of the negative equity gap. If you decide to sell a car with negative equity, you will need to pay the difference in cash or convert it into a new loan.
Things to know about loan-to-value when refinancing
If you are refinance a car Instead of buying a new one, the same rules apply. The lower your LTV, the greater your chance of a loan approval and better loan terms.
The biggest difference with refinancing is that your car has had more time to depreciate, resulting in a higher LTV.
Now, if you owe more than the car is worth, focus on lowering your LTV to improve your chances of getting a loan approval. That can mean waiting for the refinance so that you have time to repay your current loan. Your lower LTV may allow you to qualify for a lower interest rate and payment, making it worth the time you wait to refinance.