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When you apply for a second mortgage, the lender will use your combined loan-to-value ratio (CLTV)—the total amount borrowed relative to your home's value—to determine your eligibility and loan terms.
Understanding how CLTV works and why it matters with home equity loans and home equity lines of credit (HELOCs) can help you evaluate your options and determine whether taking out a second mortgage is the right step for you.
What Is Combined Loan-to-Value Ratio?
The combined loan-to-value ratio is a metric that lenders use to evaluate your application to tap your home equity with home equity loan or HELOC. It's calculated by adding up your primary mortgage loan balance and your desired home equity loan amount or HELOC credit limit, then dividing that sum by your home's value.
For example, let's say that your home is appraised for $500,000. Your mortgage loan has a $350,000 balance, and you're interested in applying for a $50,000 home equity loan.
To calculate your CLTV, you'll add $350,000 to $50,000, giving you a total financed amount of $400,000. Then, you'll divide that by $500,000, giving you an answer of 0.8, or a ratio of 80%.
Combined Loan-to-Value Ratio vs. Loan-to-Value Ratio
CLTV is essentially an extension of the loan-to-value ratio (LTV) lenders use when you take out a mortgage to buy a home.
The only difference between the two is that the LTV calculation includes only your primary mortgage balance, while CLTV is determined using all obligations that use the property as collateral.
While that's usually just one home equity loan or HELOC, it is possible to have multiple home equity products at the same time.
Taking the previous CLTV example, you'd calculate the LTV of your primary mortgage loan by dividing your $350,000 balance by the $500,000 appraised value, giving you an LTV of 70%.
Why Combined Loan-to-Value Ratio Matters for Home Equity Loans
As with a traditional mortgage, a home equity lender can foreclose on your home if you stop making payments on your home equity loan or HELOC.
However, because your primary mortgage is the first lien on the home, your mortgage lender gets first dibs on the proceeds from selling the home. Once that debt is satisfied, the home equity lender can recoup what you owe from the amount that remains.
Because foreclosed homes typically sell for less than the property's market value, there's a risk that the home equity lender won't get enough from the sale to cover the full amount you owe. As a result, here's how lenders use CLTV to determine when you apply:
- Your eligibility: Most home equity lenders only allow you to borrow up to a CLTV of 85%, though some may go higher or lower than that—some even go up 100%. If you have very little equity in your home, you're unlikely to qualify for a home equity product.
- How much you can borrow: Even if you have significant equity, a lender's CLTV limit may impact how much you can borrow. If your primary mortgage LTV is 75% and the home equity lender's maximum CLTV is 85%, for instance, you can only borrow 10% of your property's value.
- Other requirements: If you want a home equity loan or HELOC with a higher CLTV, other eligibility criteria, such as the minimum credit score and debt-to-income ratio (DTI), may be more stringent. If you have a high DTI and poor credit, your options may be limited.
- Interest rate: Even if you can stay below the CLTV threshold, a higher CLTV poses more of a risk to lenders. As a result, you can expect to pay a higher interest rate to compensate the lender for that risk.
How to Improve Your Odds of Qualifying for a Home Equity Loan
If you're thinking about a home equity loan or HELOC, your CLTV is just one of many factors that lenders consider when determining your eligibility and loan terms.
Here are some steps you can take to maximize your odds of getting approved with favorable terms:
- Only borrow what you truly need. Depending on what you need the loan or line of credit for, do your research upfront to determine exactly how much you need. While it may be tempting to borrow more—home equity products tend to have lower interest rates than personal loans and credit cards—it's best to keep your CLTV as low as possible.
- Make sure your credit is solid. The minimum credit score for a home equity loan or HELOC is typically 620, but some lenders may require 680 or more. Even if you meet the minimum credit score requirement, however, you may have trouble securing a low interest rate.
- Consider other ways to meet your needs. If you're thinking about using a home equity loan or HELOC to do some home renovations, pay down high-interest debt or pay for a large upcoming expense, consider other ways to accomplish your goal to minimize how much of your equity you need to tap. This can include building up your savings, looking into 0% APR credit card offers and considering a personal loan that won't use your home as collateral.
- Shop around. Each lender has different eligibility criteria for home equity applicants. Comparing preapproved offers from multiple lenders can give you a chance to ensure that you're getting the best deal for your needs.
Check Your Credit Before You Get Started
Before you start shopping around for a home equity loan or HELOC, check your credit score and credit report for free with Experian to get an idea of where you stand. If your score needs some work, use your credit report to identify areas you can improve, then take steps to do so.
Depending on your situation, this may include things like paying down credit card balances and getting caught up on past-due debts. If you find inaccurate information on your credit report, you have the right to file a dispute with the credit reporting agencies.
Once your credit is in good enough shape, weigh the pros and cons of tapping into your home equity and research all other options to make sure it's the best path forward for you.