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What is LTV?

Japan real estate LTV ratio tall building with high ratio between base and roof

LTV stands for “Loan-to-Value.” It is part of the phrase “Loan-to-Value Ratio.” LTV is often used when discussing mortgages, both for one’s home, and for investment property. It is a measure of how much the bank is willing to lend the real estate buyer relative to the price of the property. For example, if the LTV ratio is 72%, then that means that for every ¥100 in loan sought to buy the piece of real estate, the bank will put up ¥72; the investor puts up the remaining ¥28 in the form of a down payment.

The formula for the LTV ratio:

LTV ratio = Mortgage Amount ÷ Assessed Property Value

Examples of LTV Ratios for Popular Mortgages

Japan real estate LTV ratio calculator piles of gold coinsFor an example of an LTV ratio, let’s look at the Flat 35 mortgage, which is one common type of loan (intended for buying a home to use as a primary residence). Flat 35 is sponsored by the government, and is for terms of 21-35 years (for terms of up to 20 years, the Flat 20 is used). Although it is a government-sponsored loan, it is obtained through a private financial institution such as a bank. At the moment, the LTV for the Flat 35 is less than 90%. In other words, the home buyer pays at least a 10% down payment, and the creditor covers the other 90%.

 

 

For example, let’s imagine a salaryman named Haruto who has just settled down and started a family. He is interested in buying a home with a purchase price of ¥30 million. If he applies for, and receives, a Flat 35 mortgage with an LTV ratio of 90%, then he can make a down payment of ¥3 million and finance the rest (¥27 million). All he has to do is make his mortgage payments (consisting mostly of repayment of the principal and interest), and in 35 years, the home will be his outright.
In this scenario:

LTV ratio = ¥27 million that the bank will offer in credit ÷ ¥30 million that the property is up for sale for

LTV ratio = 0.9 = 90%

In the case of a mortgage for one’s primary residence, the 90% offered by Flat 35 mortgages is actually on the conservative side. LTV can be 100% or even more than 100% (this is called an overloan). For example, if Haruto buys a home for his family valued at ¥30 million, and he gets a 100% LTV loan, then he will not have to make any down payment at all; the bank will lend him 100% of the value, and as long as he makes his mortgage payments faithfully for the next 35 years, he can live there and eventually own it outright.

Pros and Cons of High LTV

Pros:

  • Someone with very little capital can make great ROI if the investment turns out to be a good one. For example, if one makes a down payment of ¥10 million to buy a ¥100 million property, then the LTV ratio is 90%. If that property then generates 5.5% ROI (which is ¥5,500,000 per year in rental income), then in reality, that person has leveraged ¥10 million to make a ¥5.5 million yen ROI per year—55% ROI! Of course, realistically, taxes, mortgage payments, maintenance and repairs, etc. would shave off some of this ROI, but even so, it would be an incredible return if compared to buying the property in cash.

Cons:

  • Because there is more risk for the lender, the requirements for a high-LTV loan are more stringent.
  • The interest rate might also be higher.
  • Mortgage insurance of some sort might be required, for example, Group Credit Life Insurance (団体信用生命保険, Dantai Shin’yō Seimei Hoken), in case the borrower passes away before repaying the mortgage.

The Advantage of Buying Real Estate in Japan

Japanese LTV ratios are extremely high. The government-sponsored Flat 35 offers about 90% LTV for a primary residence, and even investment property LTVs are typically around 80%. Compare this to the United States, in which LTV is typically only 70% or so, maybe slightly under 80% for someone with excellent credit who assumes high interest rates and takes out Mortgage Insurance.

Differences Between Mortgages for One’s Primary Residence vs. Investment Property

Japanese real estate LTV ratio calculator pie chartThe LTV ratio is usually lower for an investment loan than for a home loan. For home loans, an LTV ratio of 100%, or even more than 100% (called an “overloan”) are common. For investment loans, the LTV ratio must be 90% or less by law. Investment loans are a bigger risk than home loans, due to the fact that the investor taking out the loan already has a roof over his or her head, and might not work as hard to make the payments on time and in full, so financial institutions are both not willing to take as much risk , and the government also legislates that 90% is the maximum LTV ratio for this type of loan.

 

 

However, there are ways in the legal gray area in which some individuals bend the law to get an LTV ratio higher than that. For example, if the property is actually worth ¥5 million yen, and the investor declares to the bank (often using a second contract specifically for this purpose) that the property is worth ¥5,555,555 yen, then the bank might extend a ¥5,555,555 loan, 10% of which is covered by the investor as a down payment (¥555,555) and the remaining 90% which is covered by the bank (¥5 million). In this way, an investor can obtain a loan that is effectively 100% LTV, though with questionable legality.

Factors Affecting the LTV Ratio

Japan real estate LTV ratio bankThe down payment affects the LTV Ratio. If the buyer puts ¥5 million down on a home with a value of ¥20 million and the bank covers the other ¥15 million, then that is an LTV of 75%, and the buyer will qualify for better interest rates and lower barriers to entry than if the LTV were, say, 90%.

Other things can affect the LTV ratio as well, though. Remember, the LTV ratio assessment made by the bank is based on value, not purchase price. Therefore, if a property is valued at ¥20 million, the buyer puts down ¥5 million yen, and manages to persuade the seller to drop the price by ¥1 million (to ¥19 million), then the bank only needs to lend ¥14 million instead of ¥15 million. Therefore, the LTV ratio drops from 75% to 70%.

Conclusion

Japan real estate house with shrubberyLTV stands for Loan-to-Value and is the amount of money the bank will lend for a purchase expressed as a percentage. For the purposes of making large returns with small initial investments, a low Loan-to-Value is best (the power of leverage), however, a low Loan-to-Value is riskier and can command a higher interest rate and the need to take out mortgage insurance, which can impact those returns. Therefore, there is no correct or incorrect choice, so make sure to crunch the numbers first.

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