If you’re in the market for a mortgage or another type of loan, it’s important to understand the factors lenders look at. These factors help determine whether your lender will approve your loan application, and what rates and terms to offer if they do. One of these factors that you may not have heard of is the loan-to-value ratio (LTV).
But what exactly is an LTV, and why does it matter when it comes to applying for a loan?
Key Points
- A loan-to-value ratio measures the loan size relative to the property value.
- High LTV mortgages may have higher interest rates and may require mortgage insurance.
- Sometimes if a ‘type B’ property has a lower LTV, mortgage default insurance will still be required.
- Lower LTV mortgages are less risky for lenders. This reduces the lender’s risk and allows them to offer lower rates in return.
What Is A Loan-To-Value Ratio?
A loan-to-value ratio measures the loan amount relative to the value of the asset being purchased with the loan. It’s commonly used in real estate and mortgage lending and is expressed as a percentage.
A lower LTV means that you require a smaller loan amount relative to the cost of the home. On the other hand, a higher LTV ratio means that you need a higher loan amount to pay for the purchase of the home. Over time, your LTV decreases as you continue making loan payments and if the asset’s value appreciates.
How To Calculate Your Loan-To-Value Ratio?
A loan-to-value ratio is calculated by dividing the loan amount by the value of the property. The result is then multiplied by 100 to get a percentage. The formula is as follows:
| (Loan Amount ÷ Property Value) x 100 |
For example, let’s say you’re buying a home that’s worth $500,000 and need to take out a loan of $400,000 to finance the purchase. In this case, your loan-to-value ratio would be as follows:
($400,000 ÷ $500,000) x 100
=(0.80) x 100
= 80%
In this example, your LTV would be 80%.
High Ratio Vs Low Ratio LTVs
A high LTV ratio is typically anything greater than 80% and is considered a higher risk. It also may require mortgage insurance. Conversely, a low LTV ratio is usually no more than 80% and is considered a lower risk. Generally speaking, it doesn’t require mortgage insurance.
Let’s break down how the two differ:
| High Ratio LTV | Low Ratio LTV | |
| Definition | LTV ratio greater than 80% | LTV ratio of 80% or less |
| Lender Risk | Higher risk because the borrower has less equity in the property | Lower risk because the borrower has more equity in the property |
| Mortgage Default Insurance | Often required to protect the lender against default | Typically not required |
| Interest Rates | May be lower due to reduced risk for the lender from mortgage default insurance | Often higher |
Learn more: High Ratio Mortgages And Default Mortgage Insurance
Why Are Loan-to-Value Ratios So Important?
Lenders use LTVs to determine how large of a loan you require relative to how much the property is actually worth. Essentially, it’s a measure of risk, as higher LTVs are considered riskier than lower ones. That’s because a higher LTV ratio means that a larger portion of the asset in question is being financed with the loan.
Do Lenders Prefer Lower LTV Ratios?
The more money you owe relative to the value of the asset, the more of a risk you would be considered in the eyes of the lender. Higher LTVs mean that the borrower is providing less of their own money as a down payment to buy the asset in question, and therefore is at a higher risk of defaulting on the loan or creating a debt load they cannot handle.
In order to minimize risk, lenders generally prefer working with lower LTV ratios. However, some lenders may still work with higher LTVs (under 80%), but they may charge higher interest rates to lower their risk.
That said, it isn’t always true. Some lenders actually offer lower rates on mortgages with smaller down payments. That’s because of mortgage default insurance, which protects the lender in the event that borrowers default on their mortgage. So, a mortgage that’s insured reduces the lender’s risk. In turn, they may be more willing and able to offer lower rates.
Learn more: Why Do Smaller Down Payments Qualify For Lower Mortgage Rates?
How Do LTV Ratios Affect Mortgage Default Insurance?
Your loan-to-value ratio will determine whether mortgage default insurance is required. If it is needed, your LTV will determine how much insurance is required.
As noted earlier, an LTV over 80% may likely necessitate mortgage default insurance (also known as CMHC insurance). In this case, the specific amount required depends on the exact LTV.
How Much Mortgage Default Insurance Will You Have To Pay?
Generally speaking, the higher your LTV, the more expensive your mortgage default insurance premiums will be.
The following chart outlines the current costs of mortgage default insurance as determined by your LTV:
| LTV Ratio | Insurance Premium Cost on the Loan |
| Up to and including 65% | 0.60% |
| Up to and including 75% | 1.70% |
| Up to and including 80% | 2.40% |
| Up to and including 85% | 2.80% |
| Up to and including 90% | 3.10% |
| Up to and including 95% | 4.00% |
Learn more: Mortgage Default Insurance (CMHC Insurance)
To illustrate how much you could potentially pay for mortgage default insurance, let’s use an example:
- Home price: $500,000
- Down payment: $50,000 (10%)
- Loan amount: $450,000 ($500,000 – $50,000)
- LTV ratio: 90% ($450,000 ÷ $500,000) x 100
- Insurance rate: 3.10% (for a down payment between 10% – 14.99%)
Using the applicable mortgage default insurance rate of 3.10% on a $450,000 loan amount, the calculation would continue as follows:
- $450,000 x 3.10% = $13,950
If you incorporate this added premium into your mortgage (rather than paying upfront), your new loan amount would be as follows:
- $450,000 + $13,950 = $463,950
What Is A Good Loan-To-Value Ratio For Refinancing?
To refinance your mortgage, you’ll typically need an LTV of less than 80%. In other words, you should have at least 20% equity in your home before applying to refinance your home loan.
That said, some lenders may accept higher LTVs for a refinance, although other aspects of your financial profile must be quite healthy for this. A higher LTV also often means a higher interest rate.
Further, the Canadian government recently introduced a program that allows homeowners to refinance up to 90% of their property value to add secondary suites. This program is meant to provide more housing options and will take effect on January 15, 2025.
Learn more: How To Calculate Your Home Equity
Final Thoughts
Whether you’re applying for a mortgage, car loan, or any other similar type of loan that typically requires some form of down payment, your loan-to-value ratio matters. It may not be possible for everyone to provide a large down payment. But finding the right balance between a low loan-to-value ratio and not over-extending yourself is an important part of borrowing.
