A 125% loan typically refers to a loan, often a second mortgage or home equity loan, with a Loan-to-Value (LTV) ratio of 125%.
Here’s what that means:
- Loan-to-Value (LTV) Ratio: The LTV ratio compares the amount of the loan to the appraised value of the property securing the loan.
- Formula: Loan Amount / Appraised Property Value ×100 = LTV percentage
- 125% LTV: A 125% loan means you are borrowing an amount equal to 125% of your property’s appraised value.
Example: If your home is appraised at $300,000, a 125% loan would allow you to borrow up to $375,000.
Key Characteristics and Context:
- Negative Equity: Since the loan amount exceeds the property’s value, this type of loan puts the borrower into what’s often called negative equity or being “underwater” on the loan.
- Purpose: These loans were historically popular for homeowners who wanted to:
- Consolidate high-interest debt (like credit cards) into a single loan with a lower interest rate, even if they had little or no home equity.
- Access cash beyond the value of their equity.
- Risk and Interest Rates: Because the loan is for more than the collateral is worth, it is significantly riskier for the lender. As a result, these loans typically carry higher interest rates than traditional mortgages.
- History: Loans with very high LTVs, like the 125% loan, became more common in the 1990s and played a role in the housing bubble and financial crisis of 2007-2008. They are less common today due to stricter lending standards, but some products (like certain renovation or debt consolidation loans) or government-backed refinance programs have allowed for high LTVs in specific circumstances.