Understanding what the loan-to-value ratio is and how it can impact your mortgage is vital to understanding how real estate financing works. Whether you are looking to buy a house in Brampton, a condo in downtown Toronto, or use the existing value in your current home in Ontario to access much-needed cash, you are going to need to know what the loan-to-value ratio is and how it impacts your life.
It could be the difference between getting the home of your dreams or missing out.
Here we are going to explore how the loan-to-value ratio works in Ontario.
What is it and why does it matter?
The LTV ratio is a metric that compares the price of an asset being used as collateral with the value of a loan being requested in exchange for a lien on that asset.
For lending purposes, LTV is an important factor that is used to determine if borrowers can secure financing, how much money they can receive and what interest rate they will be charged. The higher the LTV ratio of a requested mortgage or loan, the less likely the borrower is to get approved by a lender. If the borrower does get approved with a high LTV ratio, they will be charged a higher interest rate than borrowers with lower LTV ratios.
In Ontario, mortgages with an LTV above 80% are required by the Canadian government to have mortgage default insurance. This ensures that the lender will be paid if the borrower defaults on their mortgage. If you want to avoid paying for mortgage default insurance, ensure that you have a down payment worth at least 20% of the home you wish to buy.
Major financial institutions like banks and credit unions can provide mortgages with a maximum value of up to 95% of the home, or an LTV ratio of 95%.
For some lenders, like private lenders, LTV is the single most important criterion they use to determine loan approval. Private lenders have very few regulations when qualifying borrowers for loans, as they do not require credit scores or income to approve loans (although these factors do influence the interest rates they can provide), instead they use LTV.
In Ontario, private lenders can offer mortgages and home equity loans with an LTV of up to 75% for homes in urban areas and 65% for rural homes. Homeowners can also get a
HELOC (home equity line of credit) with an LTV worth up to 65% of their home’s total value.
It is important to note that the LTV ratio only applies to secured loans.
What Does Loan to Value Mean When Buying a House?
When you are in the process of buying a home, the LTV signifies the percentage of the home’s value that is being covered by your mortgage.
It determines how much of your home has a lien attached to it, or in other words, is being used to secure a loan of some kind, in the case of buying a home that would be your mortgage.
What Does "Loan to Value" Mean with a Mortgage?
When it comes to mortgages, the term ‘loan to value’ is used to compare the value of the asset being used as collateral and the value of the loan being offered in exchange. In most cases, the asset is a home, but it can be other types of property.
The LTV ratio is a key factor used to evaluate mortgage and home equity applications, as lenders need to know the value of the property being used as collateral to determine if the loan is worth the risk.
When applying for a mortgage your lender will consider the mortgage’s estimated LTV. The higher the LTV the more likely a lender is to reject a mortgage application or offer a high-interest rate. You can lower the LTV of your mortgage by increasing the size of your down payment or looking for a cheaper home on the market.
Your LTV ratio will also be used by lenders if you want to access your property’s equity to secure funding.
As you pay off your mortgage, you will increase your home equity and decrease the mortgage’s LTV ratio. As you accrue more home equity, you will be able to access additional financing options from lenders. Home equity loans usually have a lot of collateral for lenders, so they often come with lower interest rates than personal loans. Homeowners in need of cash can use their home equity to access more affordable forms of funding and use the money for anything they want, provided they have a good enough LTV ratio.
What is a Good Loan-to-Value Ratio?
An LTV at or under 75% is recommended. Generally speaking, the lower the LTV the more likely a loan or mortgage is going to be approved, so a ‘good’ LTV is the lowest possible one you can get.
The lower the LTV of a given loan, the less risk the lender incurs by approving the loan. Not only does this mean that the borrower’s loan application is more likely to be approved by a lender, but the borrower also has a better chance of getting a low-interest rate and saving thousands over the course of their loan.
When a borrower defaults on their mortgage or any other secured loan, the lender has the legal right to sell their property to get their money back. This can be done through legal actions such as a power of sale, or foreclosure.
A loan or mortgage with a lower LTV is less likely to lose the lender money, and thus, more likely to be approved. If the lender does have to sell the asset, a smaller percentage of the property’s proceeds will be needed to get their money back. If a borrower defaults on a loan with a high LTV, the lender may lose money even after selling the asset if its value declined since the start of the loan. A higher LTV loan is a much riskier bet for lenders to make.
How is the Loan-to-Value Ratio Calculated?
LTV is calculated by dividing the value of the loan by the total market value of the property. Then multiply that value by 100%.
For example, let’s say you want to get a mortgage so you can buy a home in Toronto for $1,000,000.
If you have a down payment of $200,000, you will need to get a mortgage worth $800,000 to make up the difference and purchase the property.
To calculate the LTV of your loan, you will need to divide $800,000 by $1,000,000:
$1,000,000 = 0.8
Now you must multiply the answer by 100
0.8 x 100 = 80
So, in this scenario, the LTV of your mortgage would be 80%.
Get Actionable Real Estate Advice in Ontario for Free
If you want to buy a home in Ontario or secure a loan from a lender in the province, one of the most important factors that will affect your application’s approval is the loan-to-value ratio.
Some will need you to have a high credit score and verified sources of income for the last 2 years. It is the only requirement many private lenders use for loan approval, and it is among the most important factors for lenders like banks and credit unions. Regardless of which lender you decide to work with, you will need to understand the LTV ratio.
If you want to learn more about your home’s LTV, your home equity, and what kind of lending options in Ontario are available to you, call (416) 499-2122 or visit Mortgage Broker Store for a free real estate consultation.
Their team of real estate professionals has been active in Ontario's real estate industry for over a decade. During your consultation, they will work with you to understand your financial situation, including the LTV of your mortgage and any other secured loans you have to help inform you of your options.