Combined Loan to Value Ratio: What it is, How it Works

The combined loan to value (CLTV) ratio is a calculation used by mortgage and lending professionals to determine the total percentage of a homeowner's property that is encumbered by liens. The CLTV ratio is determined by adding the balances of all outstanding loans and dividing by the current market value of the property. For example, a property with a first mortgage balance of $300,000, a second mortgage balance of $100,000 and a value of $500,000 has a CLTV ratio of 80%.

Lenders use the CLTV ratio along with a handful of other calculations, such as the debt to income ratio and the standard loan to value (LTV) ratio, to assess the risk of extending a loan to a borrower. The CLTV ratio differs from the standard LTV ratio because the latter only compares the balance of one loan to the value of the property. In the above example, the property has a LTV ratio of 60%, which is derived by dividing only the balance of the first mortgage by the value of the property.

Many economists attribute relaxed CLTV standards to the foreclosure crisis that plagued the United States during the late 2000s, among other factors. Beginning in the 1990s and especially during the early and mid-2000s, homebuyers frequently took out second mortgages at the time of purchase in lieu of making down payments. Lenders, eager not to lose these customers' business to competitors, agreed to such terms despite the increased risk.

Prior to the real estate bubble that expanded from the late 1990s to the mid-2000s, the standard practice was for homebuyers to make down payments totaling at least 20% of the purchase price. Most lenders kept customers within these parameters by capping LTV at 80%. When the bubble began to heat up, many of these same companies took steps to allow customers to get around putting 20% down. Some lenders raised LTV caps or did away with them completely, offering mortgages with 5% down payments or less, while others kept LTV requirements in place but raised CLTV caps, often to 100%. This maneuver enabled customers to take out second mortgages to finance their 20% down payments.

The foreclosure spike beginning in 2008 underscored why CLTV is important. Having skin in the game, such as a $100,000 initial cash outlay for a $500,000 house, provides a homeowner with a powerful incentive to keep up his mortgage payments. If the bank forecloses, he not only loses his home but also the pile of cash he paid to close. Requiring equity in the property also insulates lenders from a dip in real estate prices. If a property is valued at $500,000 and the total liens add up to $400,000, the property can lose up to 20% of its value without any lien holders receiving a short payment at a foreclosure auction.