A high ratio loan is a loan whereby the loan value is high relative to the property value being used as collateral. Mortgage loans that have high loan ratios have a loan value that approaches 100% of the value of the property. A high ratio loan might be approved for a borrower who is unable to put down a large down payment.
For mortgages, a high ratio loan usually means the loan value exceeds 80% of the property's value. The calculation is called the loan-to-value (LTV) ratio, which is an assessment of lending risk that financial institutions use before approving a mortgage.
Steps to calculate:
1.) The LTV ratio is calculated by dividing the amount borrowed by the appraised value of the property.
2.) Multiply the result by 100 to express it as a percentage.
3.) If the value of the loan after your down-payment exceeds 80% of the LTV, the loan is considered a high ratio loan.
Lenders and financial providers use the LTV ratio to measure the level of risk associated with making a mortgage loan. If a borrower can't make a sizable down-payment and as a result, the loan value approaches the value of the appraised value of the property, it'll be considered a high ratio loan. In other words, as the loan value gets closer to 100% of the property value, lenders might consider the loan too risky and deny the application.
The lender is at risk of borrower default particularly if the LTV is too high. The bank might not be able to sell the property to cover the amount of the loan given to the defaulted borrower. Such a scenario can easily occur in an economic downturn when housing properties typically decrease in value. If the loan given to the borrower exceeds the value of the property, the loan is said to be underwater. If the borrower defaults on the mortgage, the bank will lose money when they go to sell the property for a lower value than the outstanding mortgage balance. Banks monitor LTV to prevent such a loss.