What Your Loan-to-Value Ratio Means for Your Auto Loan

Your loan-to-value ratio is the percentage of a car's worth that you're borrowing

Your loan-to-value ratio, or LTV, is the amount you're financing divided by what the car is actually worth. If you buy a car worth $20,000 and borrow $16,000, your LTV is 80 percent. If you put down $5,000 and borrow $15,000, your LTV is 75 percent. Lenders use this number to decide whether to lend to you, what interest rate to charge, and how much you can borrow.

The lower your LTV, the less risk the lender takes on. A car loses value the moment you drive it off the lot, so lenders want to know they could sell it for enough to cover what you still owe if you stop paying. When your LTV is high — meaning you're borrowing close to the full value — the lender has less cushion if that happens.

LTV matters most when you're shopping for a loan or trying to understand why a lender offered you certain terms. It also affects what happens if your car is totaled in an accident before you've paid off the loan.

Key Takeaways

• Your LTV is calculated by dividing the loan amount by the car's value; an 80 percent LTV means you're borrowing 80 percent of what the car is worth.
• Lenders typically prefer LTVs of 80 percent or lower, and may charge higher interest rates or deny loans with LTVs above 100 percent.
• A higher down payment lowers your LTV and usually gets you a better interest rate.
• If your car is totaled and your LTV is above 100 percent, you'll owe the difference between what insurance pays and what you still owe on the loan.

How lenders use LTV to set your interest rate

Lenders pull the car's value from pricing guides like Kelley Blue Book or NADA Guides, not from the dealer's asking price. This is important: a dealer might list a car at $22,000, but if the guide value is $20,000, the lender uses $20,000 to calculate your LTV. You could think you're at 80 percent LTV and actually be at 90 percent.

Most lenders prefer an LTV of 80 percent or lower. At that level, you'll see their best interest rates. Between 80 and 100 percent, rates go up — sometimes by a full percentage point or more. Above 100 percent (called being "upside down"), many lenders won't touch the loan, or will only do it if you have excellent credit and a co-signer.

Credit unions and banks often have stricter LTV limits than buy-here-pay-here dealers or subprime lenders. If you have poor credit and a high LTV, you may only find lenders willing to work with you at much higher rates, or you may need to make a larger down payment to lower your LTV first.

Why your down payment is the fastest way to improve your LTV

Every dollar you put down reduces the amount you borrow and immediately lowers your LTV. A $3,000 down payment on a $20,000 car drops your LTV from 100 percent to 85 percent. That single move can mean the difference between a 6 percent interest rate and a 9 percent one over a five-year loan — thousands of dollars in total interest.

If you're shopping for a loan and the rates feel high, ask the lender what your LTV is and what rate you'd get at 80 percent LTV. Then calculate whether saving for a bigger down payment makes sense. Sometimes it does: putting down an extra $2,000 to hit 80 percent LTV might save you $1,500 in interest over the life of the loan.

Down payments also protect you if the car depreciates faster than you pay down the loan. Cars lose value quickly in the first year or two, so starting with a lower LTV gives you a buffer.

What happens if you're upside down on your loan

You're upside down when you owe more than the car is worth — an LTV above 100 percent. This happens most often when you finance a brand-new car with little or no down payment, because new cars drop 15 to 20 percent in value in the first year. If you financed $25,000 on a $25,000 car and a year later it's worth $21,000 but you still owe $23,000, you're upside down by $2,000.

Being upside down isn't a problem as long as you keep making payments. But if your car is totaled in an accident, your insurance will pay you the car's current value — $21,000 in the example above. You still owe $23,000 to the lender. You have to pay the $2,000 difference out of pocket, even though you no longer have the car. This is called being "underwater" on your loan.

Gap insurance covers this difference. It costs $500 to $1,000 at purchase and pays the gap between what insurance pays and what you owe if the car is totaled. If you're financing a new car with a high LTV, gap insurance is worth considering.

How to calculate your own LTV before you buy

Start by finding the car's value using Kelley Blue Book, NADA Guides, or Edmunds. Enter the year, make, model, mileage, and condition. These sites will give you a range; use the middle estimate. That's the number lenders will use.

Then divide the amount you plan to borrow by that value and multiply by 100. If the car is worth $18,000 and you plan to borrow $14,400, your LTV is 80 percent. If you plan to borrow $16,200, your LTV is 90 percent.

Once you know your LTV, call a few lenders — your bank, a credit union, an online lender — and ask what interest rate they'd offer at that LTV with your credit score. This gives you a real picture of what the loan will cost before you walk into a dealership. Dealers often inflate the LTV by using inflated values, so knowing your number in advance protects you.

LTV limits vary by lender and your credit score

Banks and credit unions typically cap LTV at 100 to 110 percent for borrowers with good credit, and lower for those with fair or poor credit. Some won't lend above 100 percent at all. Subprime lenders and buy-here-pay-here dealers have fewer restrictions but charge much higher interest rates to offset the risk.

Your credit score affects the LTV limit as much as the interest rate does. A borrower with a 750 credit score might get a loan at 100 percent LTV, while a borrower with a 620 score might be capped at 85 percent LTV from the same lender. If your credit is lower, a bigger down payment becomes even more important because it both lowers your LTV and improves your chances of approval.

If you're rejected for a loan because your LTV is too high, you have two options: save for a larger down payment to lower the LTV, or wait a few months while you pay down other debts and improve your credit score. Either move makes you a lower-risk borrower and opens up better loan terms.

Frequently Asked Questions

What LTV should I aim for?

Aim for 80 percent or lower if you can. At 80 percent LTV, you'll see the best interest rates most lenders offer. Every 10 percent above that typically costs you in higher rates. If you can only afford a higher LTV, that's okay — just understand it will cost more in interest over the life of the loan.

Can I lower my LTV after I buy the car?

Yes. Every payment you make lowers the amount you owe, which lowers your LTV. You can also make a lump-sum payment toward the principal. If you come into money, paying down the loan faster gets you out of an upside-down situation sooner and saves you interest.

Does LTV affect my monthly payment?

Not directly. Your monthly payment is based on the loan amount, interest rate, and term. But LTV affects your interest rate, which does affect your payment. A lower LTV gets you a lower rate, which lowers your monthly payment.

What if the car's value drops after I buy it?

Your LTV goes up. If you financed $16,000 on a $20,000 car (80 percent LTV) and the car is now worth $18,000, your LTV is now 89 percent. This is normal and expected. As long as you keep making payments, it's not a problem unless the car is totaled.

Is gap insurance worth it if my LTV is below 100 percent?

It depends on the car and how much you put down. New cars depreciate fastest in the first year, so even an 80 percent LTV can become upside down quickly. Gap insurance is cheaper at purchase than later, so if you're buying new and want peace of mind, it's reasonable to add it.