When a lender considers your application for a mortgage, many things come into play – your credit status, the amount you have to put down as a deposit, your other debts and financial responsibilities, and more.
Another key issue when it comes to their decision is the loan-to-value ratio, or LTV.
What is LTV?
The LTV is the amount of money you want to borrow compared to the value of the property you want to buy. This is then expressed as a percentage.
To calculate the LTV, divide the amount you want to borrow by the value of the property, then multiply by 100.
Say you have a deposit of £25,000. If you want to buy a property valued at £250,000, you would need to borrow £225,000. The LTV is therefore calculated as follows:
225,000 divided by 250,000 = 0.9, multiplied by 100 = 90% LTV.
If you wanted to buy that same property with a deposit of £50,000, then the LTV would be 200,000 divided by 250,000 = 0.8, multiplied by 100 = 80%.
How does LTV affect a mortgage?
Lenders often have a maximum LTV that they are prepared to offer, so no matter how perfect a borrower’s credit score or how high their income, they won’t go beyond that point.
The LTV also affects the structure of the deals potentially available to you. Lenders fine-tune the mortgage products they offer based on perceived risk. All things being equal, the less you borrow in relation to the value of the property you buy – in other words, the lower the LTV – the lower the perceived risk and so the lower the fees and interest rates are likely to be.
The opposite is also true; if you are seeking a high LTV mortgage, you may have to accept that it’s going to cost you more. The good news is that as you make regular mortgage payments, the LTV drops, and so when it comes time to remortgage you may be eligible for better deals.
LTV and equity
Equity is the value of the property after what is owed on it is deducted. Initially that will be the price less the deposit. As you make regular mortgage payments, your equity will increase. Equity is positively impacted by rises in property prices, and as equity goes up, the LTV goes down. That means you can benefit without it costing you anything. The other side of that coin is that if prices go down, equity is negatively impacted.
Pros and cons of lower and higher LTV
Broadly speaking, if you have few debts and a fair income, but not much in savings, a higher LTV mortgage may be best for you. Conversely, if you have a good sum in your savings account, you may benefit from putting more down as a deposit to get a lower LTV mortgage.
When you are trying to get your foot on the property ladder for the first time, you might have to accept that a slightly more expensive, higher LTV mortgage is the way to go. The alternative is to delay buying a property until you have saved up a bigger deposit, in order to reduce the LTV and get a better deal. However, you risk losing a property you have your heart set on, and if house prices rise, you might not get the return you were hoping for on your additional savings.
Only you can decide which course of action is best for you, but an independent mortgage advisor like Mortgagemove will be able to provide further guidance.