Loan-to-value ratio, or LTV, is a phrase we often see thrown about when the housing market is being discussed, though many are left clueless as to what it actually means.
It is, in fact, a rather simple concept. We’ll explain exactly what LTV is, and what the implications are of a higher or lower LTV on your mortgage.
What is loan-to-value?
The average salary in the UK as of early 2015 is around £22,000, while the average house price is more than ten times this at just over £270,000.
As you can see, even with a lot of saving involved, it would take an incredibly long time for any of us to have enough cash to buy a house outright. Therefore for most of us, at least in the UK, in order to buy a property, some kind of loan or mortgage is necessary.
The loan-to-value is the ratio between the value of the loan you take out and the value of the property as a whole, expressed as a percentage. The remaining value is paid as a deposit.
Say you want to buy a house worth £300,000, and you have £60,000 in your account that you can use as a deposit. You’ll need a loan of £240,000 in order to purchase the property, and so your LTV will be 80% since 240,000 = 80% of 300,000.
Calculating LTV is fairly simple; just take the amount you need to borrow, divide it by the value of the property and then multiply the result by 100 in order to get its percentage value.
To see this in reference to the above case:
240,000/300,000 = 0.8
0.8 X 100 = 80
What LTV ratios are available?
The lowest LTV mortgages available come with a ratio of 60%, going right up to 100% for the highest. Below 80% is considered ‘low’, with 85-90% and upwards considered ‘high’.
Low LTV mortgages come with low interest rates but high deposits, and vice versa for loans with high ratios.
What is a good LTV?
As a general rule, the higher the LTV, the higher the risk on the part of the lender, as more money is being lent out to someone with less capital to put up front in the first place as a deposit. This translates into higher interest rates.
A loan with a lower LTV ratio is less of a risk for the lender, and for the borrower since less is being borrowed, and so will generally be a cheaper product.
Of course, other things like your credit rating will also affect the interest rates you are offered.
As a customer, whether or not you’d be better with a higher or lower LTV will depend on whether you place more off importance on smaller monthly payments or on a smaller deposit. Of course, high LTV means low deposit and vice versa.
Because of the risks associated, customers with poor credit histories will generally be offered low LTV mortgages, and high LTV mortgages will be offered to those with much better credit scores.
If you can afford the deposit, a mortgage with a low LTV will work out well in the long run with lower interest and a lower overall capital value to pay off.
If you’ve got a good enough credit score, as well as the means to maintain the payments, a mortgage with a high LTV will allow you to get onto the property ladder with very little put forward up front.
There is however, a very high risk of borrowers defaulting in high LTV mortgages though, given the high interest and capital.
Indeed loans with LTV of 100% and even higher are sometimes available but the number of borrowers being offered these and subsequently defaulting on them is thought to be a significant factor that cause the house price crash in 2010.
High LTV mortgages are often desirable for first-time buyers with little up front capital, but given the risk involved, many opt instead to go through housing schemes like help to buy, which offers a similar outcome without quite so much danger.
Help to Buy
Help to buy is a scheme launched by the government to help first-time buyers get on the property ladder without being stung by inflated interest rates and unaffordable loan repayments.
After the financial and house price crashes between 2007 and 2011, the proportion of high LTV mortgages being offered shrunk drastically when compared to loans with lower ratios. This spelt danger for first-time buyers without the capital necessary to afford a low LTV mortgage.
Help to buy works in two ways, both broadly aimed at allowing buyers to purchase a property without paying more than 5% of the property value as a deposit.
The first way is only applicable to those buying new-build homes, and involved the government offering a 20% loan to the buyer. The second way it works, and this is where it relates to LTV, essentially involves the government guaranteeing the lender 15% of the loan value so that they can offer a 95% LTV mortgage with less risk involved.
Save, Save, Save and Compare
While there are various schemes like help to buy in place to help you out, the best thing you can do if you want to buy a new property is, rather simply to save as much as you can and put as much as you can up front as a deposit.
Whatever your requirements, if you need a mortgage to help purchase your new property, compare quotes online to ensure that you’re getting the best deals around.
Use our mortgage comparison service to get yourself a list of the cheapest quotes on the market so that you can move in as soon as possible.