What is loan to value and why is it so important?

For prospective homeowners and lenders alike, loan-to-value (LTV) ratio plays an important part in the mortgage process. We explain what it is, how to calculate it and why it matters.

For prospective homeowners and lenders alike, loan-to-value (LTV) ratio plays an important part in the mortgage process. We explain what it is, how to calculate it and why it matters.

Mark Gordon
From the Mortgages team
4
minute read
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Posted 13 AUGUST 2021

What is loan to value?

If you’re thinking about buying a house, chances are you’ll come across the phrase ‘loan to value’ (LTV).

Although it’s a term that can be applied to any secured loan – it’s most commonly used in relation to mortgages.

The loan-to-value ratio is the number that lenders use to help them decide whether to approve a loan, and what the specific terms of that loan should be.

The higher the LTV, the greater the risk to your mortgage provider – and if it’s too high, your mortgage may not be approved.

How is loan to value calculated?

The loan to value is the ratio between the value of the loan (mortgage) you take out and the value of the property. It’s shown as a percentage.

There are LTV calculators available online, but it’s a simple formula that you can easily do on your phone.

LTV = (loan amount ÷ property value) x 100

For example, if you’re buying a house worth £500,000 and you’re looking for a mortgage of £300,000 then:

£300,000 ÷ £500,000 = 0.6
0.6 x 100 = 60
LTV = 60%

Why is loan to value important for your mortgage lender?

For your lender, the LTV is an indicator of the potential loss they’d make if you defaulted on your payments.

Lenders rely on the fact that if you can’t repay your mortgage, they can sell your house to get their money back. However, the closer the loan amount is to the total value of the property, with even just a small drop in house prices they’ll be looking at making a loss.

Why is loan to value important for you?

As a rule, the lower the LTV, the lower the interest rate you’ll be offered but the larger the deposit you’ll need. Other factors can affect the interest rate you’re offered, though, like your credit rating.

If you have a poor credit rating, you’ll generally be offered low LTV mortgages. That’s because borrowing less means a lower risk to you when it comes to making repayments, as well as for your lender.

What’s considered a good loan to value ratio?

Unlike the rating provided by your credit score, there’s not a single figure to represent a ‘good’ loan-to-value ratio.

Generally, the lower the loan to value, the fewer the risks for all involved – you and your lender.

If you want to get a mortgage, it’s a case of balancing how much you can afford in monthly payments against the size of the deposit you have available. If you don’t have much money for a deposit, a higher LTV mortgage is one way to get your hands on the keys to a new home.

How to reduce your LTV

There are two very effective ways to reduce your loan to value ratio:

  1. Save for a bigger deposit. The larger your down payment, the more money you’re likely to save in the long run. Aim for at least 20% of the property value, which creates an LTV of 80% or less.
  2. Set your sights lower. While we all tend to have a dream house in mind, buying something that’s older, smaller or in a less desirable location will make your money go further and reduce your LTV.

Frequently asked questions

What are LTV bands?

Most mortgage lenders separate their mortgages into loan-to-value bands, which usually go up in increments of 5%. With each band, you qualify for a new mortgage rate.

If you can find a bigger deposit – even by just a few thousand pounds – or a cheaper property, you might be able to drop into a lower LTV band. This can then give you a better rate and save you potentially thousands of pounds across the full term of the mortgage.

Why do lenders offer 95% mortgages?

95% mortgages were scarce during the coronavirus pandemic, but in April 2021 the government launched a new 95% mortgage scheme. It’s aim is to help homeowners with little upfront capital, as well as first-time buyers who are struggling to get on the property ladder.

The loans come with a government backing to give lenders peace of mind. However, the same credit checks apply and you’ll have to prove that you can afford the monthly repayments. So it can still make sense to wait, if you can, and save for a bigger deposit.

How does LTV affect re-mortgaging?

Unless you have an interest-only mortgage, you’ll be slowly shrinking the size of your mortgage balance with every monthly repayment - and gradually reducing your LTV at the same time. And if your home has gone up in price, then your loan-to-value ratio may be even lower.

If the terms of your mortgage allow, you may also be able to make extra payments without having to pay a penalty (typically up to 10% of your mortgage balance each year), accelerating this process still further.

This means that if you want to re-mortgage at some point, you might be able to apply for a different LTV band: one that gives you access to better deals and lower interest rates.

If my house price drops, what happens to my LTV?

If the value of your property goes down, your loan-to-value ratio is likely to go up.

If the value of your property drops to a point where it’s worth less than the mortgage you have on it, you’re in what’s known as negative equity.

For example, if you borrowed £190,000 to buy a £200,000 house, your LTV would be 95%. However, if the value of your home dropped to £185,000 and you still owned £190,000, your LTV would increase to 102.7%.

This is one reason to opt for low LTV mortgages if you can, as they offer you a bigger buffer against falling house prices.

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