The Loan-To-Value (LTV) ratio is probably the most important of the 3 Mortgage underwriting ratios.
The Loan-To-Value ratio is defined as:
LTV Ratio = Total Loan Balances (1st mtg + 2nd mtg, etc) / Fair Market Value of the Property.
First let's look at the numerator. If the borrower is only applying for a first mortgage, and there will be no other loans on the property, then the beginning balance of the new loan requested should be inserted in the numerator.
However, if the borrower is applying for a second mortgage, then the "underwriter" (the person who determines whether or not the loan qualifies or underwrites), will insert the sum of the first and second mortgages in the numerator. When the borrower is applying for a second mortgage, the loan-to-value ratio is often known as the combined loan-to-value ratio (CLTV ratio).
Now let's look at the denominator. Generally the fair market value of a property is determined by an independent appraisal. There is one important exception, however. When the proceeds of a mortgage loan are used to buy the same property that is securing the loan, then that mortgage is known as a "purchase money loan." If the appraisal comes in lower than the purchase price in a "purchase money" transaction, then the lender will use the LOWER of the purchase price or appraisal.
Commercial Mortgage Lenders are often asked by real estate agents and buyers to base their loan on the appraised value rather than the purchase price. Their claim is that they have negotiated a super deal and that the property is worth much more than what they are paying for it. This may be so (although generally untrue); the only true indicator of value is the marketplace in which "a willing buyer and a willing seller, each in full knowledge of the salient facts, and neither under undue pressure, agree upon terms." If the property sells for "X," then it is probably only worth "X." It is a regulatory requirement that lenders always base their maximum loan on the lower of purchase price or appraisal.
