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FRM Part I · FRM Exam Part I · Mortgages and Mortgage-Backed Securities

A borrower buys a home for $400,000 and takes a mortgage of $320,000. The lender's appraisal values the home at $380,000. Which loan-to-value (LTV) ratio would the lender typically use, and what is it?

Lenders usually compute LTV using the lower of the purchase price and appraised value. Here the appraisal of $380,000 is lower, so LTV is 320,000 divided by 380,000, which equals about 84.2%. Using the $400,000 price would understate the lender's exposure.

  1. A80.0%, using the purchase price
  2. B84.2%, using the appraised valueCorrect
  3. C84.2%, using the purchase price
  4. D76.0%, using the appraised value

Explanation

Lenders typically base LTV on the lower of purchase price and appraised value. The lower is $380,000, so LTV = 320,000/380,000 = 84.2%. Using the price gives 80%, which understates risk.

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