Definition: The Loan-to-Value Ratio (LTV) is a measure of how much of a property’s value is being financed by a mortgage. Calculated as a percentage, it represents the loan amount relative to the property’s appraised or market value. For example, if a buyer puts a 20% down payment on a home, the LTV ratio is 80%, meaning the mortgage covers 80% of the property’s value.

How the loan-to-value ratio is calculated

The LTV ratio is calculated by dividing the mortgage loan amount by the appraised property value:

For example, if a home is valued at $500,000 and the borrower’s mortgage is $400,000, the LTV ratio is 80%.

Importance of the loan-to-value ratio

• Risk assessment for lenders: The LTV is a primary factor lenders use to assess risk. A higher LTV indicates that the borrower has less equity, increasing the lender’s risk if the borrower defaults.
• Insurance requirements: In Canada, mortgages with an LTV of more than 80% require mortgage default insurance, commonly called CMHC insurance, to protect lenders from potential losses.
• Interest rates and terms: Generally, lower LTV ratios may allow borrowers to access more favourable mortgage rates and terms, as they present lower risk to the lender.

Loan-to-value categories

• High-ratio mortgage (LTV over 80%): A high LTV ratio means the down payment is less than 20%, which requires mortgage insurance to mitigate lender risk.
• Low-ratio mortgage (LTV 80% or lower): A low LTV ratio indicates a down payment of 20% or more. These mortgages are often eligible for lower rates and do not require mortgage insurance.

Managing your LTV

Lowering the LTV ratio can save borrowers money on insurance premiums and potentially reduce interest costs. Options to reduce LTV include:

• Increasing the down payment to lower the amount borrowed relative to the property’s value.
• Opting for a lower-priced property if affordability is an issue, as this can reduce the overall loan needed.
• Regular payments and lump-sum contributions to reduce the mortgage principal, effectively lowering the LTV over time.

Conclusion

The LTV ratio is a critical factor in mortgage approval, insurance requirements, and interest rates. A lower LTV can open doors to better financing options, making it a valuable consideration for anyone planning to buy or refinance a home.

Last modified: November 5, 2024