What is a Loan to Value Ratio?

If you are obtaining a mortgage, you may feel overwhelmed by the jargon that comes with the territory. From affordability to equity, it can be daunting trying to understand what different terms mean.

This article explains one such term: Loan to Value. We explain how loan to value is calculated, what lenders use it for, and how it can affect your mortgage application. Let’s jump in.

What is Loan to Value (LTV)?

Loan to Value is the amount you are borrowing compared to the value of the property you are purchasing, expressed as a percentage. Lenders calculate your loan to value when assessing whether a mortgage presents a high level of risk. Every lender has a cut-off point where a loan to value ratio is considered too risky and they will not lend.

For example, it is virtually impossible to obtain a mortgage at 99% of a property’s value. Historically, lenders have been comfortable offering 95% mortgages, but with the property market currently in decline, these products are being offered less frequently.

You may also see mortgage products advertised as 0% deposit options, such as the Family Springboard mortgage. In reality, these mortgages still involve a deposit, typically around 10% of the property value, which is held in a linked savings account rather than paid directly toward the purchase.

Why is Loan to Value So Important?

Loan to Value is important to lenders because it helps them assess how much risk a mortgage presents. The higher the loan to value percentage, the greater the risk to the lender. This is because if the property market declines, you could fall into negative equity. Negative equity occurs when the amount you owe on the mortgage is higher than the value of the property.

Lenders are particularly concerned about negative equity because it can make it difficult to recover the full amount of the loan if the property has to be repossessed and sold.

Repossession

Repossession is considered a last resort by lenders and usually only happens when mortgage payments have not been maintained. It is a legal process where the lender takes possession of the property and sells it to recover the outstanding mortgage debt. In most cases, the property is sold at auction to achieve a quick sale.

If a property is in negative equity, the lender may be unable to recover the full mortgage balance from the sale. This results in a financial loss for the lender, which is why high loan to value mortgages are considered significantly higher risk.

How is Loan to Value Calculated?

To calculate a loan to value ratio, the lender compares how much you are borrowing against the value of the property. For example, if you are borrowing £180,000 on a property worth £200,000, the difference between the two figures is £20,000. This £20,000 is your deposit.

The loan to value ratio is expressed as a percentage. In this example, the loan of £180,000 represents 90% of the property value, meaning the mortgage has a 90% loan to value ratio. Your £20,000 deposit represents the remaining 10%, so you would own 10% equity in the property from the outset.

Does LTV Affect Interest Rates?

Yes, your interest rate is influenced by a number of factors, including loan to value. The interest rate charged will reflect the overall risk profile of the mortgage. Lower interest rates are usually associated with lower-risk products, while higher interest rates tend to apply to higher-risk borrowing.

When it comes to loan to value, the more you borrow in relation to the property value, the higher the risk to the lender. As a result, higher LTV mortgages generally come with higher interest rates.

This is why mortgage deals requiring a 10% deposit typically offer better interest rates than those requiring only a 5% deposit.

What is a ‘Good’ Loan to Value Ratio?

A good loan to value ratio is one where the lender has less risk lending to you. The larger the deposit you can put down, the less you need to borrow. Borrowing a smaller amount relative to the property value represents lower risk to the lender.

There is no single rule for what counts as a good loan to value ratio, as each lender assesses risk differently. As a general guide, the less you borrow against the property value, the lower the risk your mortgage presents to a lender.

For buy-to-let mortgages, lenders typically require a much lower loan to value ratio. For example, many lenders ask for a minimum deposit of 25% of the property value. Buy-to-let mortgages are considered higher risk than residential mortgages due to factors such as rental voids, so lenders mitigate this risk by requiring larger deposits.

Finally, there is no such thing as a risk-free mortgage. Lenders always take on some level of risk when offering a mortgage. Loan to value ratios are simply one way for lenders to reduce that risk, not eliminate it entirely.

How Does LTV Affect Remortgaging?

Loan to value usually affects remortgaging in a positive way. If you have a five-year fixed rate mortgage, for example, you will have been making repayments for five years. Those repayments increase the amount of equity you hold in the property.

By the time you come to remortgage, this increased equity should improve your loan to value ratio and represent less risk to a lender. As a result, you may find your remortgage deal comes with a lower interest rate.

Negative Equity and Remortgaging

Problems can arise if the property market experiences a downturn and house prices fall. In some cases, you may have little or no equity in the property when it is time to remortgage.

If this happens, you may need to put down an additional deposit to reduce the loan to value ratio to a level that is acceptable to a lender.

If you find yourself in negative equity during your mortgage term, it is always best to plan ahead and speak to a mortgage broker to understand what options may be available to you.

Speak to a Specialist

Boon Brokers is a Whole of Market Mortgage, Insurance and Equity Release Brokerage. We provide fee free advice and can assist if you are struggling with the loan to value on your mortgage. Contact us today to book your free consultation with one of our dedicated mortgage advisers today.