Downward Pressure on LTV (Loan-To-Value Ratios)

In the last few years, there has been consternation surrounding mortgages and residential property valuations. With the average 30-year fixed-rate mortgage between five and six percent, there have been some fears that there would be instability in the Canadian real estate market, especially for homeowners who acquired their homes at the peak of the pandemic-era housing boom.

One metric that many industry observers monitor is the loan-to-value (LTV) ratio. But what is it?

Loan-to-Value (LTV) ratios measure the amount of money borrowed for a mortgage compared to the value of the purchased property. A low LTV ratio suggests the borrower made a larger down payment and, as a result, maintains less debt than the property’s value.

Indeed, there has been a wide range of reasons to explain the downward pressure on LTV ratios.

The first is that federal and provincial government regulators and lending institutions may have imposed stricter rules on mortgages to advance and encourage greater stability in the Canadian housing market and potentially reduce the risk of default.

The second component is that growing recession fears – or a stagnating economic environment – have prompted lenders to become more cautious, forcing them to tighten their lending requirements to manage their risk exposure better.

What about residential property values? According to the Canadian Real Estate Association (CREA), in January, the MLS® Home Price Index (HPI) declined by 1.9 percent month-over-month and was down 12.6 percent year-over-year. This may lead to lenders trimming LTV ratios to shield themselves from losses in the event of a default.

Lastly, lenders may have also reduced the LTV ratio if a borrower has a poor credit history and is a high-risk prospect.

Remember, Canada’s regulations limit the LTV ratio that a borrower can obtain for a mortgage. It is typically set at a maximum LTV ratio of 80 percent for uninsured mortgages.

The important thing to understand is what a low LTV ratio means for the Canadian housing market.

What Does This Mean for the Canadian Housing Market?

A lower LTV ratio means lower risk for the borrower and the lender. This is because the borrower has more equity in the property and is, in most cases, less likely to default on the loan.

Of course, there can be exceptions, but generally, this is what it indicates.

In addition, a lower LTV ratio offers protection against declining property values because the borrower has a greater cushion to absorb potential losses.

Therefore, downward pressure on LTV ratios in the Canadian housing market can lead to lower risk. But this cannot be taken as a blanket statement, as the LTV ratio is just one factor. Many other factors can affect the risk profile of the housing market. These include overall economic growth, interest rates, and employment rates, as these factors can significantly impact the demand for housing and the level of risk.

Meanwhile, downward pressure on LTV ratios can affect sellers and buyers differently.

Lower LTV ratios can make it different for buyers to obtain mortgages as they would be required to come up with a larger down payment, thus making it difficult for them to enter the housing market. This is especially true for people who do not have savings or access to significant funds. On the other hand, lower LTV ratios can also benefit buyers by giving them greater equity in the property and reducing the risk of default.

Ultimately, buyers who make a larger down payment can have greater security and stability.

When it comes to sellers, a lower LTV ratio can reduce their pool of potential buyers and may make it difficult for them to sell their property. At the same time, lower LTV ratios lessen the risk of default and make the housing market less volatile.

Ultimately, the benefits and risks of a lower LTV ratio can depend on the circumstances of the buyer and seller and the market conditions.

A More Stable Housing Market in Canada

What is clear is that downward pressure on LTV ratios can make the Canadian housing market relatively low risk as there is less risk of default, more stability in the housing market, and less chance of a housing bubble or crash.

While it is only one of the factors that can contribute to changing market conditions, it has the potential to change the market dynamic. Investors, buyers, and sellers should consider LTV ratios and other important factors when assessing their plans/investments in the Canadian housing market. Lower LTV ratios may be ideal for buyers who have money. However, they are not entirely suitable for first-time buyers who cannot afford to contribute a sizeable down payment. Nor for people primarily trying to get a property that would enable them to substitute their rent payment for their mortgage payment.

Many Canadians cannot afford a large down payment and rely on lenders to fund a larger chunk of the property value. Low LTV ratios are not feasible for these buyers, but in theory, downward pressure on LTV ratios reduces the risk for the Canadian housing market.