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What Is a High Ratio Loan?

Esther Ejim
Esther Ejim

A high ratio loan is used to describe a situation where the calculation of the down payment required to access a loan is significantly lower than is the norm for such a loan. Loans like this are more common in real estate transactions where a bank accepts a much lower than normal down payment from the person borrowing money for the loan. This type of loan is very risky, because it exponentially increases the risk that the bank has to assume by granting that particular loan.

The risk involved in the granting of a high ratio loan makes it necessary for the financial institutions granting the loan to also require the borrower to obtain insurance as a form of protection for the bank. Insurance also serves as a means by which the financial institution will spread the risk involved in granting the loan to the borrower, since the insurance company takes some of the burden associated with a potential default off the financial institution. Even though a high ratio loan may sometimes be granted to certain customers, the high risk associated with it means that the financial institution must be extremely selective when considering those who will be given such a privilege. Part of their considerations for granting a high risk loan is the creditworthiness of the borrower, which may be determined by a very high credit score rating.

Man climbing a rope
Man climbing a rope

As such, even though a borrower may not have enough money to put up as an adequate down payment, he or she may still qualify to be granted the loan if the borrower has a very good credit score. Some banks may also require a borrower to further obtain insurance, depending on their policy. Another way in which financial institutions justify the granting of a high ratio loan, or compensate for the granting of the same, is through the charge of a much higher interest rate in comparison to loans that have a much lower ratio.

One of the risks involved with the granting of a high ratio loan includes the possibility that the borrowers might not fulfill their own end of the bargain. This is in addition to the fact that a dip in the housing market could have a potentially disastrous consequence for the parties in a loan. Also, the burden of the higher interest rate placed on the borrower might lead to a default on repayment.

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