Loan-to-value, otherwise known as ‘LTV’ is a phrase that you’ll quite often hear used within the housing and mortgage market. It’s something that lenders look at when assessing the level of risk attached to any secured loan they may be considering offering. It will often drive the level of interest rate being charged.
It’s an important part of the mortgage process, but what does LTV actually mean? In this article, we explain everything you need to be aware of regarding loan-to-value.
What does LTV mean on a mortgage?
In the mortgage world, LTV is a calculation used by lenders use to describe the relationship between the outstanding mortgage balance and the market value of a property. It refers to the percentage of your property’s market value that is being funded by your mortgage.
For instance, let’s say you put down a 20% deposit on a property. You take out a mortgage to cover the remaining 80%. Your LTV ratio would be 80% because 80% of your home is being paid for by your mortgage.
The higher the LTV, the higher the risk profile for the lender. This is because, in the event of you defaulting your mortgage for any reason, a higher LTV means there is a smaller buffer between what is owed on the mortgage and what the market value of the property might be.
Your LTV ratio will change over time. This is often a result of you paying down your mortgage borrowing each month. This reduces the mortgage amount against the property value. It may also change as a result of the market value of your property changing. A rise in the value of your house will reduce the percentage of your property funded by your mortgage. As a result, it will reduce your LTV.
For example, a £200,000 house with a £160,000 mortgage will have a loan-to-value of 80%. If the market value of the property increases to £220,000, and the mortgage remains at the same level, the LTV will reduce to around 73%. Remember, however, that houses values can go down as well as up. A fall in your property’s market value could result in the LTV increasing.
How does LTV affect interest rates?
To compensate lenders for the higher risk associated with providing higher LTV mortgages, these mortgages generally attract a higher interest rate. Similarly, mortgages with lower LTVs are usually offered at lower interest rates. This means that it can be much cheaper to borrow the same amount of money if there is a lower LTV.
Are higher LTV mortgages really more risky to the lender? Well, think about it this way. A home bought with a 90% mortgage would only have to lose 11% of its value to go into negative equity. This is where the market value of the property isn’t sufficient to cover the balance outstanding on the mortgage. As a result, if the lender were to have to repossess the property for any reason and then sell it to try and recoup the amount outstanding on the mortgage, the sale proceeds wouldn’t be enough to get all of their money back.
Lenders also know from experience that properties that get repossessed tend to have suffered neglect for some time prior to this. Very often, they fail to reach their full market value at auction. As a result, the reduction in value seen in such properties will see them not get all their money back.
A lower loan-to-value mortgage of 60% however, means that the market value of a property can fall by over a third before the lender faces any real risk of loss. This is why lenders save their more attractive mortgage deals for customers with lower LTV borrowing.
Find out more – ‘How much interest am I paying on my mortgage?’
How to calculate LTV
LTV is expressed as a percentage. It is calculated by dividing the value of the mortgage outstanding by the value of the property. There are plenty of online LTV calculators to help you do this.
Let’s say for example that you wish to purchase a house for £200,000. You intend on putting down a 20% deposit of £40,000. To complete the purchase, you will need a mortgage of £160,000. By dividing the required mortgage (£160,000) by the property value (£200,000) and then multiplying by 100, you get the LTV which is in this case 80%.
What is a good LTV?
So, we now know that low loan-to-value mortgages are generally preferable and often come with lower interest rates. High LTV mortgages are considered higher risk and often come with higher interest rates. But what exactly is considered low and high for LTV?
As a general rule, anything below 80% LTV is considered low. Anything higher than 80% is considered high. For that reason, it’s a good idea to try and put down at least a 20% cash deposit. Of course, this can be difficult for first-time buyers. It’s not uncommon to have a higher LTV mortgage when you purchase your first property. As you build up equity in your property, you could then look to move on to lower loan-to-value deals later on.
For first time buyers, it can still be worth taking on the more expensive higher loan-t0-value borrowing just to take that first step onto the property ladder. After all, house prices might be going up faster than the value of your savings! If you start off with a high LTV mortgage, then you can always look to remortgage onto a cheaper facility later, once you have seen your LTV start to reduce as a result of either house price rises or your borrowing reducing (or most commonly, a combination of both).
Got more questions about LTV? Just give us a shout! Our friendly and experienced mortgage advisors would be happy to help you. Contact us via our website or call 01908 597655.