High-Ratio Loan

Definition

A high-ratio loan is a financial term primarily used in the mortgage industry to denote a loan that is equal to or exceeds 80% of the property’s appraised value or purchase price, whichever is lower. This means the borrower makes a down payment that is less than 20% of the property’s value. These loans are usually deemed higher risk, often requiring mortgage insurance.

Phonetic

“High-Ratio Loan” in phonetics is pronounced as: “hai rey-shee-oh lohn”

Key Takeaways

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1. A High-Ratio Loan is a system in which a loan is made where the loan value is close to the value of the property used as collateral, surpassing the traditional loan to value ratio of around 80%. This implies that the amount borrowed is notably larger than the equity owned in the property.
2. In most cases, high-ratio loans come with higher risk for lenders and therefore may have higher interest rates for the borrower. This is a consequence of the increased chance of default due to the smaller margin for error should the price of the collateral decrease.
3. High-Ratio Loans usually require Mortgage Insurance. This offers a protective blanket for the lenders in case of borrower default. The cost of the insurance is usually borne by the borrower and can result in higher overall costs for the loan.

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Importance

High-Ratio Loans are vital in the business and finance world because they offer the potential for individuals to purchase property or conduct business affairs even when they do not have a large amount of initial capital. Typically requiring only a minimal down payment, these loans can be leveraged by people who may not otherwise be able to secure adequate funding for their investment. However, because of the higher risk associated with these loans (due to the larger amount that is loaned out relative to the value of the asset), they usually come with higher interest rates and often require insurance to protect the lender. Thus, High-Ratio Loans represent a balancing act between risk and reward both for the lender and the borrower.

Explanation

A high-ratio loan serves a significant purpose in the financing landscape, specifically for those who are looking to purchase property but may not have a significant amount of funds for a down payment. Essentially, high-ratio loans provide borrowers with the opportunity to purchase properties with a smaller down payment, eventually culminating in a higher loan-to-value ratio. This feature of high-ratio loans is particularly advantageous to first-time home buyers or those who are investing in expensive real estate markets where the saving of a sizable down payment represents a substantial challenge.Generally, high-ratio loans enable individuals to partake in property ownership while minimizing the amount of cash they need upfront, which often provides the needed impetus for people to invest in real-estate. However, since they represent a higher level of risk for lenders, such loans typically necessitate mortgage insurance to mitigate lender risk. Therefore, while high-ratio loans may require less cash upfront, the overall cost of borrowing might be increased due to the additional insurance premiums. Taken together, high-ratio loans are valuable tools in making real estate more accessible, especially in high cost housing markets, but they do carry their own costs and considerations.

Examples

1. Home Mortgages: A common example of a high-ratio loan is a home mortgage where the borrower only makes a small down-payment. For example, if someone wants to buy a home that costs $200,000, but they only have $20,000 for a down-payment, then they need to borrow $180,000. This would be a high-ratio loan because the loan amount ($180,000) is 90% of the home’s value ($200,000).2. Student Loans: Another example could be student loans. Higher education is quite expensive and people usually don’t have enough savings to pay for it, especially when they’re just starting out in life. So if a student borrows $50,000 to pay for University fees, and isn’t able to pay back any amount initially due to lack of earnings, it’s a high-ratio loan as the loan amount is almost 100% of the money needed.3. Auto Loans: Another practical example of high-ratio loans can be seen in auto loans where buyers finance a large portion of the vehicle’s price. For instance, an individual might decide to buy a new car worth $40,000 and chooses to pay only $4,000 upfront. The remaining $36,000 will be financed, thereby resulting in a high-ratio loan with the loan-to-value ratio being 90%. Remember high-ratio loans are generally regarded as higher risk to lenders due to the little collateral the borrower has in the investment. Therefore, it’s common for such loans to have higher interest rates or require insurance.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Loan-to-Value Ratio (LTV)
• Mortgage Insurance
• Down Payment
• Debt-to-Income Ratio (DTI)
• Equity

Sources for More Information

• Investopedia
• The Balance
• Bankrate
• Bloomberg