Debt ratio or LTV ratio in real estate is expressed as a percentage and is calculated by taking the total mortgages/loans on a property divided by the value of the property. In most cases, this is used for financial lenders when determining the risk profile of a customer and their associated mortgages vs ownership of assets.
Debt ratio is also used by financial lenders to apply certain fees such as mortgage insurance depending on the thresholds they put in place for each individual and loan type.
- Example 1: A property has been bought for $300,000 with a down payment of $30,000. This means there was a $270,000 loan used to acquire the asset. The formula for debt ratio is applied - (270,000/300,000) = 0.9 (or 90%). In this example, we can see that 10% of the property based on its fair market value is owned by the purchaser and the remaining 90% is part of a loan owned by the financial lender.
- Example 2: You are looking to buy a second home as an investment property, in which case a financial lender will look at how much your current assets have grown in value to determine how much leverage you have and how much they will lend you.
In typical cases, a loan with a debt ratio of 90% is considered a high-risk mortgage. A high-risk mortgage will then be forced to pay mortgage insurance in order to secure the loan.