A high-ratio loan is a type of loan where the loan amount is significantly high compared to the property’s value used as collateral. Mortgage loans with high loan ratios typically have a loan-to-value (LTV) ratio that approaches or exceeds 80% of the property’s value, and in some cases, can be as high as 100%. These loans are ideal for borrowers who cannot make large down payments.
Key Takeaways
- A high-ratio loan has a loan amount large relative to the property value being used as collateral.
- The loan-to-value (LTV) ratio typically exceeds 80% and can approach 100% or higher.
- Such loans carry higher interest rates and pose a higher risk for lenders.
The Formula for a High-Ratio Loan Using LTV
To determine if a loan is a high-ratio loan, you can calculate the loan-to-value (LTV) ratio. Here’s how:
How to Calculate a High-Ratio Loan Using LTV
- Divide the loan amount by the appraised value of the property.
- Multiply the result by 100 to convert it to a percentage.
- If the result is above 80%, it is a high-ratio loan.
\text{Loan to Value Ratio} = \frac{\text{Mortgage amount}}{\text{Appraised property value}} \times 100
What Does a High LTV Ratio Loan Tell You?
Lenders use the LTV ratio to assess the risk of a mortgage loan. When a borrower cannot make a substantial down payment, the LTV ratio increases, indicating a higher risk for the lender. This higher risk can result in loan denial or require higher interest rates to compensate for the heightened risk.
High-ratio loans are particularly risky during economic downturns when property values may drop, making it difficult for the lender to recover the loan amount in case of borrower default. To mitigate the risk, high-ratio loans often require private mortgage insurance (PMI), which the borrower must purchase.
High-Ratio Loan History
Historically, home buyers used to provide significant down payments before building and loan companies started offering loans during the 1920s. High-ratio loans became commonplace by the end of the 1920s but posed significant risk during economic downturns, leading to the establishment of better norms and practices, including government-backed guarantees for mortgages.
Over time, through agencies like the Federal Housing Administration (FHA), down payments reduced even further to encourage home ownership. Despite these developments, the subprime mortgage crisis of 2007-2008 illustrated the dangers of high-ratio loans given to borrowers with poor credit.
High-Ratio Lenders
The Federal Housing Administration offers FHA loans where borrowers can have LTV ratios of up to 96.5%, requiring only a 3.5% down payment. These loans, however, come with insurance premiums and necessary credit score thresholds to qualify.
Example of a High-Ratio Loan
Consider a borrower purchasing a home valued at $100,000 with a $10,000 down payment. The loan amount will be $90,000, resulting in an LTV ratio of 90% ($90,000/$100,000), qualifying as a high-ratio loan with higher interest rates.
High-Ratio Loans vs. Home Equity Loans
While high-ratio loans are typically calculated based on the current appraised value of a property and can approach 100% of that value, home equity loans are second mortgages based on the difference between the home’s equity and market value. They are used by borrowers who have already paid down part of their mortgage.
In conclusion, high-ratio loans serve an important purpose for those unable to make large down payments but carry considerable risks and higher costs to offset those risks for lenders.
Related Terms: loan-to-value ratio, mortgage, private mortgage insurance, home equity loan, FHA loans.
References
- Get Rich Slowly. “A brief history of U.S. homeownership”.
- BeBusinessed. “History of The 30 Year Mortgage – From Historic Rates To Present Time”.
- GovTrack. “H.R. 1738 (98th): Homeowners Loan Corporation Charter Act”.
