How does a lender determine the LTV ratio for a mortgage?

The loan-to-value (LTV) ratio is a key metric used by lenders to assess risk when underwriting a mortgage. The correct method for calculating the LTV ratio involves taking the loan amount and dividing it by the greater of the sales price or the appraised value of the property.

This approach is significant because it ensures that the lender evaluates the amount being borrowed relative to the most accurate reflection of the property's worth. Using the greater of the two values—the sales price or the appraised value—protects the lender in instances where the property's market price might be lower than its appraised value or vice versa. If the property is appraised higher than the sales price, using the appraised value allows for a more favorable LTV ratio, reflecting a lower risk for the lender.

This method is crucial for lending decisions, as a higher LTV ratio often indicates greater risk, potentially leading to higher interest rates or the requirement for mortgage insurance. Therefore, dividing the loan amount by the greater value provides a more comprehensive assessment of the transaction's risk.

The other methods mentioned would either not appropriately reflect the property's risk level or provide an incorrect calculation of the LTV, which could mislead lenders in their decision-making processes.