Your loan to value (LTV) ratio compares the amount financed to what the vehicle is actually worth. Why it’s important is pretty simple: a lower LTV ratio usually means a better chance of getting approved for the auto loan.
What’s a Loan to Value Ratio?
A loan to value ratio is calculated by dividing your loan amount by the actual cash value (ACV) of the car you’re buying. The LTV ratio is usually expressed in a percentage. Here’s a quick example of a pretty solid deal on a vehicle with a lower LTV:
Car selling price $10,000 ÷ ACV $9,800 = LTV 1.02, or 102%
You and the lender should care a great deal about your LTV ratio. Odds are, you probably don’t want to pay more for a vehicle than it’s worth, and your lender wants to approve a loan that has low risk. The lower the LTV, the higher your chances of getting approved for the auto loan typically are.
LTV Ratio and Auto Loan Approval Odds
With a lower credit score, it’s especially important to make sure you’re not getting in over your head with a car loan. Bad credit auto lenders check a vehicle’s LTV ratio before they approve you for the loan. Since a lower credit score can mean more risk, the lender may take a LTV ratio more seriously.
If you apply for a loan amount that’s much higher than what a car can sell for, it poses a risk to the lender. If something happens to the loan, such as a default, it represents a potential loss to them. If a borrower takes on an auto loan and defaults, then the lender typically repossesses the vehicle and prepares it to be sold at auction to try to cover the remaining loan balance. But if the loan balance is significantly higher than what the car’s ACV is, the lender could stand to lose a lot of cash.
It’s important to know that every auto lender differs in their specific requirements for what your LTV ratio should be. However, there are some basics for some general guidance. Ideally, you want to get a LTV ratio that’s around 100%. If you can get it below that, even better. A little over 100% is OK, too, and pretty common.
However, a LTV ratio over 125% can make it difficult to get approved for the loan. This also applies to refinancing. Lenders don’t refinance vehicles that have negative equity (when you owe more on the loan than what it’s worth).
As a general rule, you want to aim for a car that has a selling price that’s nearly equal to its current appraised value. It’s uncommon to purchase a vehicle that’s selling price is exactly what it’s worth (which would be an LTV of 100%), but it can happen. It’s also possible to get a LTV ratio that’s under 100% – which means you're getting a great deal!
Why the Loan to Value Ratio Matters to You
Even if you do get approved for an auto loan with an LTV over 125%, that doesn’t mean it’s a good idea. Starting out a car loan with lots of negative equity can potentially cause problems down the line for you.
If you need to sell the vehicle in the future but your loan balance hasn’t caught up to the car’s value, it could mean not getting an offer high enough to pay off your auto loan. It also means you may not be able to refinance the vehicle if you need to (until you catch up, that is).
If you want to see what a car’s estimated value is, you can visit sites like Kelley Blue Book, NADAguides, and Black Book. These sites offer valuations for vehicles after you enter their information. These are just estimates, but they can give you ballpark figures on what a car is selling for and what their trade-in value is. You can use these sites to check out your next potential vehicle’s value and compare it to the selling price to see if you’re getting a good deal by calculating the LTV ratio.
Bad Credit and Loan to Value Ratio
Remember, a lower LTV ratio means less risk. With bad credit, you want to lower your risk in all areas to boost your chances of getting approved for the auto loan. This means putting money down to lower your car payment and LTV ratio, and working with the right lender for your credit situation.
Finding the right auto lender for your credit isn’t always easy, but we’ve created a better way to find bad credit lending resources. Here at Auto Credit Express, we have a nationwide network of dealerships that are signed up with bad credit lenders. To get matched to a dealer in your local area, fill out our free car loan request form.