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LTV, or Loan to Value Ratio, as it is called is the ratio of a loan amount against the market value of a car that is going to be bought with the loan. In simple words, LTV is a measure or standard through which the risk of a loan is measured. Since it implies how much amount of a loan is cushioned by the real world value of the asset, it is a very important aspect of a car loan that the borrowers need to know.
The actual value of a car is most often lesser than the price that you pay while purchasing a car because a car is a depreciating asset which lost its value immediately after driving it off the showroom. In short, the moment a buyer purchase a car the value of the vehicle goes down and when the buyer drives the vehicle throughout the value continues to go down with every passing year.
While buying a car with the help of a car loan, there are a few things that you as a buyer must consider beforehand. LTV is one such factor that must be taken into consideration while using a car loan for the purpose of buying a car. To make the concept easier for you, it can be said that the LTV of your car loan is the ratio of the loan amount that you have taken to the current market value of the car that you are going to purchase with the loan.
There is a very simple formula for calculating the LTV of the loan. Here is the formula of how you can calculate the LTV of your car loan-
LTV= Loan Amount/car value
The LTV of a loan is expressed in the form of a percentage. Suppose, you are going to buy a car of Rs.3 lakh and for that, you have borrowed a car loan amount of Rs.3 lakh. In this case, your LTV will be 100% (Rs.300000/Rs.300000). Instead, if you have to borrow Rs.2, 50000 for buying a car worth Rs.2, 00000, the LTV of your loan will be 125% (Rs.2, 50000/Rs.2, 00000).
Banks lend money to the borrowers with an expectation that they will pay the money back in due time. If the borrowers don’t repay the money on time then it is a loss for the lenders. However, many times, the borrowers default on the loans resulting in a loss for the lenders.
In order to safeguard themselves from such risks, the lenders usually ask for a security or collateral while offering a loan. The reason for asking this security is to assure that in case the borrower defaults on the loan, the lender can repossess the collateral and collect the money by selling it off. In this way, the bank or the lender can recover the losses that caused due to the defaulted loan. In case of car loans or auto loans, the collateral is the car itself against which the loan is taken.
Now, the thing is that taking a security against a loan doesn’t eliminate the entire risk of a lender. Though it is true that if the lender has a security, he or she can anyway recover the money by selling it off, but it is not the case always. The borrower usually borrows more than the exact buying price of a car for multiple reasons. While some borrowers take some extra amount of money for to pay off their existing debts, some others finance protection products in their loans. As a result, the lenders often end up giving more money as loan against a car which is lesser in worth. In such cases, when the borrower defaults on the loan, the lender fails to fetch the money that he has lent the borrower resulting in loss.
This is the reason why the lenders set LTV for car loans. By setting an LTV they ensure that they in no way get exposed to high amount of risk while providing a car loan.
As told earlier, LTV is the is the total value of your loan divided by the present value of your vehicle, hence a lender while offering a car loan will seek to offer an amount which shouldn't exceed the cash value of your car which will be hypothecated to the lender as a collateral. If the loan amount is more than the worth of the car, then the lender will be exposed to greater risks in case the borrower defaults on the loan. Hence, to be on the safer side and protect himself from risk, the lender will look for a higher amount of down payment. In other words, a higher amount of down payment can reduce the loan to value ratio of your car loan.
LTV is something that every car buyer should know about in advance to get the best advance of availing a car loan. Here is an example which will help you to clearly understand how Loan to Value of a car loan works.
Example- Just imagine that you are going to buy a car which costs Rs.5 lakh and to finance the purchase of your car you want to take a loan from a bank or financial organisation. But you have to pay Rs.1,5 lakh of debt from an existing loan and also you want to make a purchase of a service protection product worth Rs.50,000. This means to finance all these costs, borrowing only Rs.5 lakh will not suffice and you have to get a loan amount much higher than the purchase cost. The total amount that you need to borrow including the extra Rs.1,5 lakh for negative equity and Rs.50,000 for protection product will sum up to Rs.7 lakh.
This means for your loan, the LTV will 110% and you need to apply for a car loan from a lender who offers such high loan amount. Though there are lenders and banks who offer car loans at this high LTV, most of the lenders consider this as high risks and deter from offering such loans. Because if you due to any reason fail to repay the loan, the lender will only be able to get the existing market value of your car at that point of time. This means that the additional 10% of the amount paid to you will be at risk.
Now assume that you don’t get a lender willing to pay you a loan at 110% LTV. Lenders are willing to give you a car loan at an LTV of 100%. In such cases, you can make a down payment in order to bring down the ratio to 100%. Particularly in this case if you make a down payment of 10% of the total amount then the LTV of the loan will come down to 100%.
The loan to value can affect the terms of a loan. While the borrower can enjoy flexible loan terms with a loan of low LTV, a high LTV might affect the loan terms and the bank might ask the borrower to make down payment in order to reduce the LTV. Usually, banks don’t ask for any down payment while offering a car loan. But if the LTV is high, in an attempt to reduce the associated risk the lenders might ask for an initial down payment.
Typically, no lender prefers to offer a car loan with LTV considering the risk associated with it. Even though, the car for which the borrower is taking the loan, will serve as the collateral or security which the lender can sell if the borrower default on the loan, the lender is at risk if he provides high LTV on the loan. This is because, even if the lender repossesses the vehicle in loan default cases, he will not be able to recover the full loan amount.
Loan to Value is a key term associated with a car loan and it is vital for the borrowers to be well-informed about this to get the best value as well as better terms on their loan. So, understand the term and make use of your knowledge while opting for a car loan next time.