The mortgage and lending professionals use the combined loan to value (CLTV) ratio to decide the total percentage of a homeowner’s property that is stalled due to debt obligations.
Along with a few other calculations, like the debt to income ratio and the standard loan to value (LTV) ratio the lenders use the CLTV ratio, to gauge the risk of giving a loan to a borrower.
Among various other factors, many economists feel that a relaxed CLTV standard led to the foreclosure crisis in the United States during the late 2000s.
Homebuyers frequently took out second mortgages at the time of purchase in lieu of making down payments at the beginning of the 1990s and the early and mid-2000s.
Greed lenders unwilling to lose these customers’ business to competitors agreed to such terms and the risks increased leading to the housing crisis.
The standard practice before the real estate bubble that filled the period from the late 1990s to the mid-2000s, was for homebuyers to make down payments adding up to at least 20% of the purchase price.
Most customers were kept within these parameters by the lender who capped LTV at 80%.
When the bubble began flaring up, many of these companies took action to allow customers to get around putting 20% down.
The LTV caps were raised by some lenders and offered mortgages with 5% down payments or less, while others kept LTV requirements in place but raised CLTV caps, to 100%. This action lets customers take out second mortgages and finance their 20% down payments.
The foreclosure spike in 2008 emphasized the importance of CLTV. Like for a $500,000 house, an initial payment of $100,000, will make the homeowner keep paying his mortgage payments.
Because if the bank forecloses, the homeowner will lose his home along with the pile of cash he paid to close.
Good equity in the property also pads up the lenders in case of a drop in real estate prices.
If the value of the property is $500,000 and the whole liens add up to $400,000, the property can drop up to 20% of its value without any lien holders receiving a short fee at a foreclosure auction.