Loan-To-Value Ratio And How It Is Calculated
In an effort to improve the financial position and social status, people oftentimes use the services of traditional financial institutions, particularly lending, to buy a car, house, expensive jewelry or to pay for funeral services etc. Accordingly, the banks determine your creditworthiness by using credit scoring to lower the risk of default, which is rather time-consuming, taxable and bureaucratical. One of such assessments is termed as a Loan-To-Value (LTV) ratio.
What Is It?
LTV ratio is a calculation that helps lenders measure the ratio of a loan to the value of an asset purchased. It is used to determine how risky the loan is. In view of the contemporary blockchain expansion and widespread use of cryptocurrencies, borrowers have an excellent opportunity to avoid credit scoring, minimize financial risks and apply for loans secured by crypto collateral. The following article describes in corresponding exhaustive detail how to calculate the LTV ratio and outlines benefits of crypto-backed lending.
LTV Ratio Formula
In order to calculate the LTV ratio, it is necessary to sum up the amount of a loan and interest, then divide into the amount of pledged collateral and finally multiply by 100. As simple as that!
Demonstratively, the formula is as follows:
Loan-To-Value Ratio = Principal Loan Amount + Interest/Total Value of Collateral × 100
At LendaBit.com, the initial LTV ratio is expressed as a percentage and it amounts to 50%. To boost the lending process, LendaBit has integrated Loan Calculator, which is a useful tool for all platform users. It helps automatically calculate loan terms, interest rate, collateral and enables to choose the preferred type of cryptocurrency.
For instance, a person owns 10 BTC and he does not want to sell it or exchange due to high tax rates and future price growth of cryptocurrencies, which will eventually supersede traditional paper money. In this case, a well-balanced decision will be to apply for a crypto loan by using P2P lending services offered by blockchain-powered platform LendaBit. By so doing, the person avoids heavy taxation and accumulates his crypto assets. The borrowing process begins when the client sends his crypto collateral to the corresponding wallet address on the LendaBit platform. LendaBit guarantees the integrity and safety of the pledged collateral amount due to utilization of Ethereum smart contract management system and implementation of next-generation platform architecture. The amount of
collateral is twice the initial loan amount because that way all platform lenders are secured from loan defaults. Once this is done, the borrower can apply for a crypto loan (all the loans are executed in USDT and BTC for better conversion into preferable currencies). Consider the following case: the client pledges 5 BTC collateral and applies for a 10 000 USDT loan for a period of 1 year with 12% annual interest rate. Numerically, the LTV ratio for the loan is as follows:
where initial LTV ratio is 50%. LTV ratio is proportionally dependent on the USDT price and when its price goes up, the client is eligible to withdraw the excess amount of collateral to their personal wallet. Conversely, if the USDT rate goes down and the LTV ratio reaches 70%, the client will be notified to top up the collateral amount.
What Is a Good Loan-To-Value Ratio?
When applying for a loan, it is a prerequisite that the initial LTV ratio must be 50%. If in due course the LTV ratio falls below 50%, it is an excellent indicator, which allows to fully take advantage of the situation. The borrower can withdraw capital gains from their LendaBit’s wallet and use at his discretion (buy more crypto, exchange to fiat, whatever!).
Contrarily, when the LTV ratio is higher than 50%, the higher closing costs and rates are. When LTV ratio reaches 70%, the client will receive a notification of Margin Call. Margin Call is a requirement to increase the collateral amount and reach the mandatory 50% ratio. Only if the LTV ratio reaches or exceeds 85%, the borrower’s pledged collateral is sent to the lender’s wallet account. Here, crypto collateral serves as a guarantee that lender’s assets are duly secured.
LTV ratio is an equilibrium both for lenders and borrowers. Essentially, lenders are motivated to securely and profitably make long-term investments, whereas borrowers avoid heavy taxation, benefit from capital gains and get lower interest rates. This is where borrowing against your crypto holdings can really pay off!
Deniss has been in asset and risk management for more than 20 years in one of the top Latvian banks.
He is highly proficient in finance, investing, blockchain and startup development.
Being CEO at LendaBit.com, he is dedicated to solving company problems using impeccable judgment and critical thinking skills.