“What is the LTV Ratio?”

 

After collateralizing your loan with crypto assets, you can stay in the crypto market while at the same time requesting cash liquidity. Evidently, this is a win-win situation. However, this raises the question of what happens when the value of your cryptocurrency assets in collateral increases or decreases. At this point, one must make themselves acquainted with an important mechanism: the LTV ratio.

 

What does it stand for?

 

First and foremost, we need to clarify what LTV is in the traditional sense. LTV is an acronym for “loan-to-value.” This ratio is an assessment of lending risk that lenders and various financial institutions examine before granting mortgage approval. For the most part, loan evaluations with high LTV ratios are deemed as higher-risk loans. Therefore, should the mortgage be approved, then the loan’s interest rate is higher.

 

Moreover, a loan with a high LTV ratio will usually require the borrower to buy mortgage insurance in order to counterbalance the risk to the lender. This type of insurance is referred to as ‘private mortgage insurance’ (PMI).

 

Interested homebuyers can calculate the LTV ratio of a home with this formula:

LTV ratio = MA / APV

In this formula, MA is the ‘Mortgage Amount’ and APV is the ‘Appraised Property Value’.

Generally speaking, a low LTV ratio means that there is a greater chance of the loan being approved. Likewise, the interest rate will probably be lower. Furthermore, as a borrower, it is less likely that you will need to purchase PMI.

 

In terms of crypto loans

 

A lot of crypto lending platforms enforce an LTV ratio of 50%. This means that, as a minimum, you need to deposit 2X the amount you are borrowing as collateral. Let’s say that a bitcoin is worth $10,000 and you are looking to borrow $20,000 cash. In this case, you need to deposit 4 BTC as collateral. After paying off the loan, you will get your collateral back. That’s all there is to it.

 

Cryptocurrency is notoriously volatile, so what happens when BTC values rise or fall? An increase means that your LTV ratio becomes more favourable since you are basically depositing more collateral. You can take out extra cash against your added value, or get out of your current loan in profit.

 

If the values decrease, your LTV ratio will go up, meaning that you have less collateral to protect your loan. If it ends up going too high – and you fail to deposit more collateral to decrease the LTV ratio – your collateral will be liquidated in a margin call in order to protect the lender’s assets.

 

A vital tool

 

Obtaining a loan is more than just borrowing money to pay off a debt or purchase something you can’t normally afford. Loans are strategic tools used by professional traders on a daily basis. One must know the ins and outs of loans, and that includes risk assessments. With that said, the LTV ratio is an important factor in lending and should be understood by borrowers and lenders alike.