When you’ve taken out a loan that’s secured by investments that are traded on the public markets, your LTV ratio can change quickly. That can sound scary, but sticking to responsible borrowing practices (like not borrowing the maximum amount) can keep your LTV ratio well below the danger zone.
What is LTV and why does it matter
The LTV is a leverage ratio that represents the share of debt on an asset. It’s a measure that indicates how exposed a borrower is to defaulting on their loan. Simply put, the higher the LTV, the greater the risk that the borrower won’t be able to pay back the debt because they don’t have sufficient equity backing the asset. A lower LTV, meanwhile, indicates the borrower has more equity and is less at-risk of defaulting.
The simplest way to understand LTV is to think of the mortgage on a home: the percentage the mortgage represents of the property’s total value is its LTV ratio. In the case of a $400,000 mortgage on a $500,000 property, the LTV would be 80%, and the homeowner’s equity is the remaining 20%. It’s why home-buyers have to get mortgage insurance if their down payments are less than 20%: they're seen as having a much higher risk of not being able to afford their mortgage payments.
Portfolio lines of credit — secured lines of credit you can take out with your financial institution where your investment portfolio acts as the collateral — tend to have lower credit limits, to try to ensure major market swings don’t compromise the loan. It also keeps the LTV on the lower side. However, when you borrow against investments, your LTV can change quickly if the market value of the underlying assets jumps or falls.
Benefits vs. risks
Benefits
Using an asset like your investment portfolio as collateral to borrow can be a powerful tool: it gives you increased buying power for investing, major purchases or life milestones like a wedding, a bucket-list trip, or renovation. It can also be used to cover unexpected expenses.
Risks
Interest rate risk: Portfolio lines of credit typically have lower interest rates than unsecured personal lines of credit, and can even have lower rates than home equity lines of credit (HELOCs). But the interest rate is variable, so if the Bank of Canada’s overnight rate increases, it can become more costly to pay down your loan.
Additional fund requirements: If you borrowed near the top of your credit limit and market volatility causes your portfolio value to drop significantly, your LTV could exceed its allowable limit — prompting your financial institution to demand you add money or eligible securities to your portfolio or pay down your loan, otherwise they may liquidate your securities.
Why market volatility changes the equation
Your LTV isn’t a static figure. If the market value of your assets drops, then your LTV will automatically rise because the loan now represents a larger share of the total.
When you borrow against your investments, there’s always a chance that a market turbulence could take a bite out of your portfolio value. If it drops significantly, it could drive your LTV up past what your brokerage allows — meaning you no longer have enough collateral to secure your loan. This is much more likely if you’ve borrowed close to or at your credit limit.
If that happens, your brokerage would issue a demand that you add funds to the investment account securing your line of credit, or sell securities to pay down the loan.
Your brokerage would give you a date you must fund your account by, and if you fail to do so in time, it can sell a portion or all of your securities to pay down the loan and bring your LTV back down. If you or your brokerage is forced to sell securities during a margin call, you might end up having to sell at a loss, or could face a tax bill depending on the account type and associated gains.
Calculating a sustainable limit
Before you borrow, you should give some thought to the worst-case scenario: if the market dropped by 20%, what would your LTV be if you had taken out the amount you’re considering? Conservative investors will generally stay below the maximum LTV their brokerage allows to account for any market volatility that could impact their portfolio value.
Here are some examples of what both scenarios might look like, if your portfolio value is $100,000, and your brokerage allows you a maximum LTV of 30%.
Let’s say you’ve borrowed $25,000 and the market drops 20%, bringing your portfolio value down to $80,000. Your LTV ratio would quickly jump from 25% to 31.25%. You would need to add $1,000 in cash or securities to lower your LTV to the 30% maximum.
If you had borrowed $10,000 and the market dropped 20%, your LTV ratio would increase from 10% to 12.5%, and you would not have to take any action since you would be well within the 30% LTV maximum.
FAQs
How can I lower my LTV ratio quickly?
You have three options for reducing your LTV ratio. You can add funds to the investment account that’s securing the loan, make payments toward the loan itself, either with cash or by selling securities (though that may be a less desirable option if you have to sell at a loss), or add eligible securities to the account.
Does LTV apply to mortgages, or just to portfolio lines of credit?
They apply to both — and in fact, someone’s LTV ratio is a central consideration for mortgage lenders. It's why homebuyers with less than 20% down are required to carry mortgage insurance — a small down payment means the lender has little protection if the borrower defaults and the home sells for less than the outstanding loan. LTV ratios just move faster when it comes to borrowing against securities, because market fluctuations can shift someone’s LTV on a daily basis, and those market swings can change the ratio significantly.