What is the purpose of loan-to-value (LTV) ratios in lending?

The purpose of loan-to-value (LTV) ratios in lending is to measure the risk of lending by comparing the loan amount to the property value. This ratio provides lenders with a clear understanding of how much of the property's value is being financed through the loan, which helps them gauge the possible risk involved in the transaction.

A higher LTV ratio suggests that the borrower is financing a larger portion of the property's value, which may indicate a higher risk to the lender. Conversely, a lower LTV ratio typically indicates more equity from the borrower, thus reducing the lender's risk. LTV ratios are crucial in determining loan approval, interest rates, and other lending terms, as they directly influence the lender's potential exposure in a deal.

Understanding this ratio enables both lenders and borrowers to make informed decisions regarding financing options and risk assessment in real estate transactions.