What is the main purpose of a loan-to-value (LTV) ratio?

The primary purpose of a loan-to-value (LTV) ratio is to assess risk by comparing the loan amount to the property's appraised value. LTV is a crucial metric used in the mortgage lending process, as it helps lenders understand the level of risk involved in providing a loan. A higher LTV ratio indicates that a borrower is financing a larger portion of the property's value, which may suggest greater risk for the lender. This is because if the borrower defaults on the loan, the lender may not be able to recover the full amount of the loan through a sale of the property.

By evaluating the LTV ratio, lenders can make more informed decisions about loan approvals, interest rates, and whether mortgage insurance is required. A lower LTV generally indicates a more secure loan, which can lead to better loan terms for the borrower. In contrast, options focusing on interest generation, mortgage insurance calculations, or investment returns do not address the primary function of the LTV ratio, which centers on risk assessment related to loan security.