According to the Consumer Finance Protection Bureau (CFPB), the loan-to-value (LTV) of a car ”is the total dollar value of your loan divided by the actual cash value (ACV) of your car.” The dollar value of a loan includes the total purchase price of the vehicle in question and any loan origination fees added by the lender. The LTV is expressed as a percentage and most lenders will not approve a loan for a vehicle with an LTV that is greater than 115 percent. This is an oversimplification, but you can think of LTV as the percentage of the vehicle that is being financed.
Why is LTV Important when Buying a Car?
The LTV is important on a few fronts. First, it will be a determining factor in whether you will be approved for a loan or not. If it is too high, a lender may require a larger down payment to secure the loan. Next, it will affect the length of the loan that you are offered. Generally, the higher an LTV, the shorter the loan length. Lastly, a high LTV will translate into a higher interest rate. You may be required to carry gap insurance as well, which covers your remaining loan balance if your vehicle is totaled. After all, your insurance only pays the value of your vehicle the day it was wrecked. If you have a high LTV, there’s a good chance that you will owe more on your car than it is worth on the day of the accident.
LTV and Risk
The reasoning behind raised rates and shorter loan lengths, as they relate to the LTV, is that lenders are risk adverse. A higher LTV means a larger percentage of the vehicle is being financed, which is a higher-risk scenario, so lenders want to recoup their money as quickly as possible and with the highest possible profit margin. You can avoid all of these ”penalties” by offering a down payment equal to at least twenty percent of the total purchase price of the vehicle you are interested in. If that is not possible, you may want to consider a less expensive model or waiting until you can offer the higher down payment.