LTV: The long and short of it.

Lower LTV is a low-risk loan to the lender as borrower’s own equity stake is high and vice-versa.

You must have observed that when you take a home or car or any other secured loan, the lender often says that, ‘we can fund you up to 80-85% and the rest you have to bring at your own’. This is nothing but maintaining and managing LTV within reasonable limits for the lender to manage its loan effectively.

The Loan-to-Value (LTV) compares the loan amount to the value (appraised or market) of the asset being used as collateral. Very simply, LTV % = (Loan Amount / Asset Value) × 100.

For example, if a borrower A seeks a loan of ₹40 lakh to purchase a property valued at ₹1 crore. LTV here is 40%. Likewise if the borrower B seeks a loan of ₹80 lakh to purchase a property valued at ₹1 crore. LTV in this case is 80%.

LTV helps the lender in many ways including:

• Risk assessment,
• Loan approval decisions,
• Interest rate determination,
• Collateral protection,
• Regulatory compliance etc.

Lenders protect their interest by way of monitoring and redressal mechanisms such as:

• Periodic Valuation: For financial assets such as Mutual Funds/ Shares, real time market prices are monitored and for real assets a periodic appraisal or valuation models are used to calculate the asset value.
• Stress Testing: A stress test is conducted to assess the impact of LTV under adverse scenarios such as market crashes or downturns.
• Margin Calls: When the collateral value drops significantly, increasing the LTV ratio beyond the permissible limit, lenders may issue a margin call where the borrower can either pledge additional collateral or repay the loan to bring back the LTV ratio within acceptable limits.
• Trigger of loan covenants: At times breaching the minimum LTV, lender may trigger covenants such as Increased interest rates, temporary suspension of loan access or may ask for early repayments.
• Insurance for collaterals: For certain loans, lenders require borrowers to insure the collateral. This ensures that any loss in value due to unforeseen events (e.g., natural disasters for property) is mitigated, indirectly maintaining the LTV ratio.

For lenders, the LTV ratio is a critical tool for balancing profitability and risk. It ensures they can recover their funds even in adverse scenarios, thereby safeguarding the financial institution's interests.

Therefore, lenders continuously monitor the LTV ratio throughout the loan tenure to manage risk, especially in loans where the collateral's value may fluctuate (e.g., shares, mutual funds, or real estate). The goal is to ensure that the loan remains adequately secured.

Keeping LTV ratio in check safeguards both the lender and the borrower and works as an early warning signals to the lender to protect their capital and borrower’s creditworthiness.