When applying for a mortgage, you’ll come across the term loan-to-value (LTV) ratio. This is an important part of the application process but what exactly is it? What does loan-to-value mean, how is it calculated and how does it affect your mortgage rate?
What does loan-to-value mean?
The loan-to-value ratio is the percentage of a property’s value that you are borrowing from a lender for a mortgage. It’s affected by how much deposit you can put down.
For example, if you’re buying a property worth £200,000 and have a deposit of £20,000, which is 10% of the purchase price, you need a mortgage of £180,000. This is an LTV of 90% as you’re borrowing 90% of the property’s value.
If you have a higher deposit of £40,000, however, this is a 20% deposit and means you can borrow a lower amount of £160,000. This gives you a loan-to-value ratio of 80% because you need to cover 80% of the property’s value with a mortgage.
The higher the LTV, the more of a risk you pose to a lender. This is because you’re borrowing a higher amount compared to the property’s value. With a lower LTV, you lower the level of risk and can usually benefit from a wider range of deals and better interest rates.
How is the LTV calculated?
To work out the LTV, you need to know the value of the property you want to buy and how much deposit you expect to have. You then deduct your deposit amount from the property price to get the amount you need to borrow. Divide that amount by the property price and then multiply the result by 100. This gives you the loan-to-value ratio as a percentage. A simple formula is:
(Loan amount ÷ property value) x 100 = LTV
Using the earlier examples of buying a property worth £200,000 with either a 10% or 20% deposit, the formulas are:
(£180,000 ÷ £200,000) x 100 = 90% LTV
(£160,000 ÷ £200,000) x 100 = 80% LTV
Why does the loan-to-value matter to a lender?
Your LTV ratio helps lenders decide whether or not to accept your mortgage application, the terms and interest rate they’re prepared to offer and the amount you can borrow.
Having a higher LTV means that you are borrowing more, which raises their financial exposure if you default. As a high LTV ratio is riskier for a lender than a low LTV ratio, they’ll charge a higher rate of interest to help mitigate this risk. On the other hand, a lower LTV ratio will be rewarded with a lower interest rate as you pose less of a risk to them.
What is a good LTV?
Lenders vary in what they consider to be a good LTV but, generally, lower than 80% is considered to be good. This will enable you to benefit from better rates.
The higher your LTV, meaning the amount you want to borrow is closer to the value of the property, the harder it is for a lender to recoup their funds if you default on the mortgage and they have to sell the property.
This is especially the case if you have a 95% or 100% mortgage. If property prices suddenly drop, you’re at risk of going into negative equity, which is when you owe more for your mortgage than the property is worth.
How does the LTV affect your mortgage rate?
As mentioned earlier, the lower your LTV ratio, the better the rate you’re usually offered, depending on the lender’s criteria and your circumstances. This lowers the amount you need to pay for your monthly mortgage payments and makes your mortgage cheaper overall. The best rates tend to be reserved for the lowest LTVs as these carry the least risk for lenders.
Lenders typically divide LTVs into bands. These are generally set in increments of 5%, depending on the lender. With each lower band that you can reach, it can help you unlock better mortgage rates.
LTV bands
- Up to 60% LTV: The lowest rates and most flexible terms are generally offered when you have a 40% deposit, giving you a 60% LTV. Paying a bigger deposit than this will reduce the amount you need to borrow, giving you more equity in your property, but you won’t usually benefit from a cheaper interest rate than can be obtained at 60% LTV.
- 65% to 75% LTV: With a 25% deposit or more, you can access a wide range of deals and benefit from competitive interest rates.
- 80% to 85% LTV: A 15% or 20% deposit gives you access to moderate rates, helping to keep your monthly payments lower and reduce the overall cost of your mortgage.
- 90% LTV: It’s a good idea to try and save at least a 10% deposit if possible. This will still give you access to better rates and more deals than if you fall into a higher LTV band.
- 95% to 100% LTV: With a 5% deposit, you’ll pay a higher rate than if you can qualify for the next band down but you’ll still be offered a better rate than if opting for a 100% mortgage. As a 100% LTV poses the most risk for a lender, this will come with higher costs but this option can be an essential way to get on the property ladder when you’re struggling to save any deposit at all.
As well as benefitting from a wider range of mortgage deals, a lower interest rate and more flexible terms, there are other benefits to having a lower LTV. It strengthens your application so that you appeal to a wider range of lenders and gives you a higher chance of being approved for a mortgage. You also benefit from having more equity in your property from the outset.
Can you improve the LTV?
There are ways you can improve the loan-to-value ratio when buying a property.
- Save a bigger deposit: You may be close to a lower LTV band. If you can save a little more to push yourself into that band, this will give you a more favourable interest rate. Your monthly mortgage payments will then be lower, as will the overall cost of your mortgage.
- Use a gifted deposit: You may be able to get help from a family member in the form of a gifted deposit. This is a sum of money to be used as your deposit, either in full or to boost your own deposit savings. It must be given as a true gift rather than as a loan that is to be repaid. Your family member will need to sign a declaration confirming this.
- Negotiate on the property price: If you can agree on a lower price with the seller, you won’t need to borrow as much and this may enable you to reach a lower LTV band.
- Buy a cheaper property: Consider buying a property with a lower price. This may mean looking for a property with fewer bedrooms or one that’s located in a cheaper area. This reduces the loan size you need so that, with the deposit you already have, you can benefit from a lower LTV.
Remortgaging
If you already own a property and know that you want to remortgage, there are a couple of ways to lower your LTV beforehand.
- Reduce your mortgage balance: Make overpayments when you can, either in lump sums or regular overpayments. Check your lender’s terms regarding overpayments first so that you don’t risk having to pay an early repayment charge.
- Increase your property’s value: Making home improvements may add value to your property. This can help you to benefit from a lower LTV.
Find the right mortgage for your LTV
Whether you have a small deposit, a substantial one or you’re looking to remortgage, our mortgage brokers can find the best deal for your needs. They know how your circumstances can affect your options and can guide you on ways to lower your LTV if you’re close to the next band. This will help to maximise your borrowing power and strengthen your application.
Give us a call on 01322 907 000 to speak with one of our mortgage experts. They’ll take the time to understand your financial situation and explain which lenders and deals may be suitable for you. With impartial advice tailored to your circumstances, you can feel confident about taking the next step with your mortgage.