A car’s loan-to-value ratio, or LTV, is the amount you want to borrow divided by the value of the car you want to buy.
Because auto loans are secured — the vehicle serves as collateral — the LTV is a way for lenders to measure how much risk they are taking when approving your loan.
You can use this formula to figure the loan-to-value ratio, expressed as a percentage:
Loan amount / car value x 100 = LTV
So if you’re borrowing $30,000 to finance a car valued at $35,000, the LTV would be 86%.
How loan-to-value affects your car loan
Because your car is collateral for the loan, lenders consider whether they could sell the car to recoup losses if you default on the loan. The less you borrow in comparison with the car’s market value, the less risk for the lender and the greater benefit for you.
The loan-to-value ratio affects your loan in several ways, from the rate you receive to whether you are approved:
Loan approval: To limit their risk, lenders have LTV ceilings for loan approval, which differ from lender to lender. LTV can affect your ability to get financing, if it surpasses the lender’s limits. Remember that LTV is just one of many factors, which can include your credit scores and history of on-time loan payments, that lenders review when deciding whether to approve your loan.
Lower rate: Because lenders use LTV to measure the risk associated with your loan, a lower LTV indicates less risk and typically results in a lower loan rate, saving you money over the life of the loan.
Down payment: Putting more down on a loan will reduce your LTV — improving your chances of loan approval and getting a lower interest rate.
Negative equity: Some lenders may let you borrow an amount that exceeds a new car’s suggested retail price or a used car’s market value, resulting in negative equity. You will owe more than the car is worth, which isn’t ideal.
How a car loan LTV can surpass 100%
If you borrow $20,000 to buy a $20,000 car, your LTV is 100%. But if you include sales tax, title and license fees in the amount you’re borrowing, you are now over 100%. Many lenders allow an LTV of 125% or more.
Another common way people end up with a high LTV is when they owe more on an existing loan than a car is worth, and they roll the negative equity into the new loan. So if you’re buying a $25,000 car and owe $5,000 on your previous loan, you could finance the full $30,000 for an LTV of 120%.
New cars typically depreciate quickly, often more than 20% in the first year, so buying a car with a high LTV makes it difficult to get out of the negative equity hole. If you decide to sell a car with negative equity, you would have to pay the difference in cash or roll it into a new loan.
What to know about loan-to-value when refinancing
If you’re refinancing a car instead of buying a new one, the same rules apply. The lower your LTV, the greater your chance for loan approval and better loan terms.
The biggest difference when refinancing is your car has had more time to lose value, resulting in a higher LTV.
If you now owe more than the car is worth, focus on lowering your LTV to improve your chances of loan approval. That could mean waiting to refinance, so you have time to pay down your current loan. Your lower LTV may enable you to qualify for a lower interest rate and payment, making the time you wait to refinance worthwhile.