Headroom, in dollars and in percent

Headroom answers how far things can move before something is required of you.

LTV tells you where you are. Headroom tells you how far away the edge is. They are the same information framed for different purposes, and the second framing is the one people can actually act on.

Headroom in dollars is the amount of collateral value you can lose before the maintenance threshold is reached. Headroom in percent is that dollar figure as a share of current collateral value. The percentage version is more useful because market moves arrive in percentages, and because it is comparable across account sizes.

trigger value = balance ÷ threshold; headroom % = (current value − trigger value) ÷ current value

trigger value: The collateral value at which your LTV exactly equals the maintenance threshold.
threshold: The maximum LTV your agreement permits, as a decimal.
headroom %: The percentage decline in collateral value you can absorb before a call is possible.

Two properties of headroom are worth internalising. It shrinks non-linearly: as collateral falls, each further percent of decline eats a larger share of what remains. And it shrinks on its own: interest accrual raises the balance, which raises the trigger value, which lowers headroom even on a day when the market did not move. Headroom is a melting number, not a stable one.

The reason to prefer the percentage version is that it can be compared with things you already know. Market declines are quoted in percent. Historical drawdowns are quoted in percent. Your own portfolio's typical bad quarter is a percentage. A headroom of thirty percent can be placed against that history immediately, whereas a headroom of one hundred and seventy thousand dollars cannot be placed against anything without more arithmetic.

There is one more adjustment that most people skip. Headroom is measured in collateral value, but markets move in index terms, and your portfolio does not move with the index one for one. Converting headroom into the market decline that would cause it requires dividing by your portfolio's sensitivity to the market, which is the next lesson. Until that division is done, a percentage of headroom is not yet an answer to how bad a market would have to get.

Key terms

Headroom: The distance between your current collateral value and the value at which a call becomes possible. Quotable in dollars or percent.
Trigger value: The collateral value at which LTV equals the maintenance threshold exactly.
Non-linear decay: The property that equal-sized price declines consume progressively more of your remaining cushion.

Worked example

Headroom melting on a flat day and a bad one

Balance $300,000, collateral value $600,000, maintenance threshold 70%.

Trigger value: $428,571
Headroom in dollars: $171,429
Headroom in percent: 28.6%
After a 15% market fall to $510,000: Headroom 15.9%
After one flat quarter at 6.5% interest, balance $304,875: Headroom 14.5%

The first 15 percent decline removed nearly half the cushion. Then a quiet quarter removed more of it with no price move at all.

Check yourself

Balance $200,000, collateral value $500,000, threshold 75%. What is headroom in dollars and percent?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.