For many years, LTV ratio was the principal factor used by rating-agency models in determining expected losses. Today, rating-agency models are much more complex, using FICO scores and other variables to forecast credit performance. However, LTV ratio is a primary variable in credit performance and, to a lesser extent, prepayments. A high LTV ratio typically indicates that a buyer is stretching to make monthly mortgage payments. Hence a high LTV ratio often is associated with a high DTI ratio, as well as other weak credit indicators.
There is also a direct link between LTV ratio and loss severity. Traditionally, the agencies would not insure loans that had LTV ratios over 85%, and any loan above 80% needed mortgage insurance. However, in recent years, the agencies instituted programs encouraging homeownership, which now allow LTV ratios of up to 95%. The additional risk represented by these loans is absorbed by mortgage insurance companies. LTV ratios in the agency and jumbo markets average around 70%. In the higher-risk sectors, such as alt-A and subprime, LTV ratios average 80% to 83%, 10% or more higher than in agency and jumbo programs.
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