A high-ratio loan is a loan whereby its value nearly reaches 80% to 100% of the property value which is used as collateral. For example, suppose someone wishes to buy a house with an appraised value of $200,000. The borrower makes a $20,000 down payment, and he has to borrow another $180,000. In this case, the loan-to-value is 90% (180,000/200,000), which should be seen as a high ratio loan.
Normally, a high-ratio loan is designed for the potential borrowers who cannot make a sizeable down payment and it is considered as a risky investment by lenders so that they may charge a higher interest rate. A typical high-ratio loan is FHA loans offered by Federal Housing Administration. This program allows borrower to pay only a 3.5% down payment yet they require a minimum credit score and a mortgage insurance premium (MIP). Although the insurance may cost a lot at the beginning, borrowers can always refinance as long as their LTV ratio is lower than 80%. When that happens, the loan is no longer a high-ratio loan and the insurance can be removed.
How does it work?
- How to calculate a high-ratio loan?
Lenders or investors can calculate the loan-to-value ratio to determine whether it is a high-ratio loan or not. To calculate loan-to-value ratio (LTV), we should divide the borrowed amount (total mortgage amount minus down payment) by the property’s appraised value. After this, we should multiply the result by 100 to make it a percentage. If it is more than 80%, the loan is a high-ratio loan.
- What does a high-ratio loan tell you?
LTV is an important indicator for lenders or investors to measure the risk. The higher the LTV is, the riskier the investment is. The LTV of a high-ratio loan is more than 80%. Consequently, high-ratio loans are generally seen as a risky investment. Lenders suppose that borrowers may default on their mortgage payment and the bank are unable to sell the collateral property to cover their loss, especially during economic depression when house price decreases significantly. Due to this, lenders will usually require borrowers to purchases private mortgage insurance (PMI) to protect their benefits.