Important ratios used in the mortgage application process: LTV, CLTV, DTI

Lenders use LTV to measure their risk of not getting their money back if you decide to blow off to Jamaica and stop making mortgage payments, and an 80% LTV is as high as they want to go without adding a cost to you to cover this risk. Considering a lender's perspective, it takes three or four months of not receiving mortgage payments before they know that a borrower is defaulting. From that point, they have legal expenses associated with foreclosing on the borrower's home and significant expenses to put the home on the market, list it with a real estate agent and sell it. In the example above, they might sell the home for $248,000, pay all of these expenses and get back the $195,000 that they lent to the borrower, but if they loaned the borrower $220,000 against that same home, you can see that they might not get all of their money back in the event of a default.

Any time your LTV goes above 80%, lenders perceive an increased risk associated with your loan -- and they take care of that risk by charging you more, one way or another. The two most common ways of handling the risk of a high LTV loan are Private Mortgage Insurance ("PMI") or splitting your loan amount into two pieces -- an 80% LTV first mortgage and a second mortgage covering the rest of your financing above 80%. Since the second mortgage bank is in second lien position, they are second in line for repayment if the borrower defaults on the loan, so they bear the bulk of this risk -- and they cover that risk by charging you a higher interest rate on your second mortgage. When two mortgages are used, lenders have a new ratio to consider, which brings us to "CLTV."

CLTV -- means "combined loan to value"
As you might guess, the CLTV ratio measures how much mortgage you're using to finance your home, as a percentage, by combining the loan amounts for more than one mortgage and dividing their sum by the value of your home. First mortgage lenders want to see a CLTV of 90% or less in order to keep you in the standard risk category; above 90% CLTV you'll see higher interest rates on the 80% first mortgage. You can go all the way to 100% CLTV, but remember that 90% or more will give you a higher interest rate on your first mortgage.

DTI -- means "debt to income"
Lenders use DTI to measure how much of your income is committed to paying monthly bills -- it's a measure of your ability to make the payments on your new loan. DTI is calculated by adding up the minimum monthly payments required on all of your credit accounts (i.e. mortgages, car loans, student loans, and credit cards -- not included are items like utilities and groceries) and dividing by your gross (i.e. pre-tax) monthly income. DTI of 45% or less puts you into a standard risk category. They'll go up to 50% in some cases (but the increase in their perceived risk means that you'll pay a higher interest rate.)