It’s important to understand how a mortgage-to-value (LTV) ratio works, whether you’re buying your first home or re-mortgaging your existing home.
The LTV ratio can have a significant impact on the overall cost of your mortgage, with a lower LTV ratio usually meaning you’ll pay less. Here’s everything you need to know.
What is the loan to value ratio?
The loan to value ratio is the proportion of the value of the property that you are borrowing as a mortgage and it is expressed as a percentage.
To calculate your LTV ratio, divide the amount of your mortgage by the value of the property you are buying and multiply the figure by 100.
For example, if you are buying a property for £200,000 with a down payment of £40,000 (20%), you would need a mortgage of £160,000. To get the LTV, divide £160,000 by £200,000 and multiply by 100. This gives you an LTV ratio of 80%.
Why is LTV important?
The LTV is an important factor in determining the interest rate you will pay on your mortgage. The lower your LTV – and therefore the larger your deposit – the more competitive the mortgage rate.
The LTV ratio is important to lenders because they want to be sure they won’t lose money if you can’t afford to pay your mortgage. If you default on your mortgage, the lender has the right to sell your property to get their money back.
However, if you have a high mortgage, there is a risk that if house prices fall, the value of your home will be lower than the value of the remaining mortgage, known as l negative equity.
Negative equity is more likely to occur if you bought your home with a small deposit. With a 95% mortgage, for example, the value of the property only has to drop by 6% to be in negative equity.
For this reason, lenders view borrowers with a high LTV as higher risk and mortgage rates will be more expensive than offers offered at, say, 70% or 60% LTV.
Here is an illustrative example of how mortgage rates can change depending on the mortgage LTV bracket. However, the exact figures will depend on market conditions, competition between lenders and where the Bank of England interest rate is going – or expected to go – at the time you are researching.
|LTV||Cost of the 2-year plan||Monthly cost*|
What is a “good” LTV?
Generally speaking, the lower your LTV, the better. Although some lenders offer mortgages of up to 95% of the property’s value, it’s ideal to keep your LTV below 80%. In addition to getting a better mortgage rate, this means you’ll have access to a wider range of mortgage deals.
Currently, the margins between the different LTV bands are relatively narrow. But if they go up at some point, it can make a big difference to your monthly mortgage costs.
For example, if a 90% LTV mortgage rate was 4.50% and an 85% LTV mortgage rate was 3.50%, the difference in monthly repayments would be £150 for a £200,000 property. This equates to £1,800 per year.
What is the impact of rising interest rates on LTVs?
Getting the best mortgage rate is especially important in times of rising interest rates – and when the cost of living is so high.
But while taking the time to save a larger deposit for a lower LTV mortgage can get you a more competitive mortgage rate, buying a home with a smaller deposit has a number of advantages.
For example, buying a house sooner could mean you’ll save money on rent and, if property prices go up, on the cost of ownership as well. It could also allow you to secure a cheaper fixed rate mortgage now, before interest rates rise further and drive up the cost of borrowing.
Deciding which option is right for you isn’t always straightforward, so it’s a good idea to speak to a toll-free mortgage broker who can discuss your options in more detail.
LTV ratios and remortgaging
As you pay off your mortgage, the portion of the property you actually own will gradually increase. This means you will have more equity in your home and your LTV will be lower.
If house prices have also risen by the time you remortgage, this will lower your LTV ratio even further. As a result, you may be able to get a more competitive mortgage rate and lower your monthly repayments.
On the other hand, if house prices have fallen or overall mortgage rates have risen significantly since you took out your mortgage, you might end up paying more when you come to remortgage. Again, there is nothing to lose by contacting a toll-free mortgage broker to review your options. You can book your next mortgage rate up to six months in advance.