The loan-to-value (LTV) ratio or simply “LTV” is a financial term used by banks and other mortgage lenders to calculate one of the risk measures of lending money for a mortgage. It calculates the size of the loan a borrower wants to take out as a proportion of the market value of the property they want to mortgage.

For example, if you want to buy a house worth £200,000 and have a deposit of £20,000, you would need to borrow £180,000 as a mortgage against the property in order to be able to complete the property purchase. In this case, the LTV ratio would be calculated by dividing the loan amount (£180,000) by the value of the property (£200,000) and multiplying the result (£180,000 / £200,000 = 0.9) by 100. The LTV ratio or LTV would thus be 90% (0.9 x 100).  

Subject to other underwriting criteria, - such as property valuation and searches, and the borrower’s credit score, debts and income and expenses, - lenders often use the LTV ratio to decide whether or not to offer the full mortgage amount applied for and what mortgage interest rate to offer.  

How Do Lenders Use the LTV Ratio?

Essentially, lenders use the LTV ratio to assess how risky it is to lend you money against your property. A higher LTV ratio means more risk for the lender. This is because you are borrowing a higher proportion of value of the property. If you default on your mortgage payments and the lender has to repossess and sell the property, they might not be able to recover the full amount of the loan.

In general, a lower LTV ratio is better for both the lender and borrower. For the lender, the loan recovery risk in case of borrower default is lower. For the borrower, it can make getting approved for a mortgage easier and may result in a lower mortgage interest rate. For instance, an LTV of 60% is considered a relatively low risk, while an LTV of 90% or more is considered a higher risk.

Why Is the LTV Ratio Important for Home Buyers?

The LTV ratio is important because it influences how much you can borrow and how much your mortgage will cost.  

A lower LTV ratio usually means a lower interest rate and lower monthly mortgage payments. It is generally also easier to obtain a lower LTV loan. On the other hand, it also means a higher upfront deposit amount.

Conversely, if your LTV is high, you are likely to face a higher interest rate and higher monthly mortgage payments. It might generally also be more difficult to obtain a high LTV loan. However, the upfront deposit will be lower.  

How Can You Reduce Your LTV Ratio?

One way to reduce your LTV ratio is to save for a larger deposit. The more money you can put down as an upfront deposit, the lower your LTV ratio will be. For example, if you save £40,000 instead of £20,000 for a £200,000 property, your LTV ratio will drop from 90% (£180,000 / £200,000 x 100 = 90%) to 80% (£160,000 / £200,000 x 100 = 80%).

Another way to lower your LTV ratio is to buy a less expensive property without reducing the deposit. You will thus not need to borrow as much. This can also help you secure a better mortgage interest rate.

What are the Common LTV Limits?

LTV ratios are often grouped together based on certain commonly recognised limits. These LTV limits typically determine the mortgage interest rate available to the borrower. Commonly used LTV limits are 60%, 75%, 80%, 85%, 90% and 95%.

Lenders usually offer the best mortgage interest rates to people with lower LTVs. For example, a borrower with an LTV of 60% or lower may get a better rate compared to someone with an LTV higher than 60% but not exceeding 75% and the latter, in turn, may get a better rate compared to someone with an LTV higher than 75% but not exceeding 80%, and so on.  

Knowing the LTV range you fall into can help you understand your borrowing options and terms, and make better informed financial decisions.

How Does the LTV Ratio Impact First-Time Buyers?

First-time buyers often have higher LTV ratios because they may not have large deposits. Many lenders offer mortgages with LTV ratios of up to 95% to first-time buyers, which means they only need a 5% deposit to fund their property purchase. This can make it easier for them to get on the property ladder.  

Generally, borrowers with higher LTV ratios should be aware that higher LTV mortgages often come with higher interest rates. It is important to budget carefully and understand what you can afford. Understanding how LTV works can help first-time buyers, as well as other borrowers, plan their finances and navigate their options more confidently.

How Does LTV Affect Your Mortgage Payments?

The LTV ratio has a direct impact on your monthly mortgage payments. A higher LTV ratio means a larger loan, resulting in higher interest payments and higher loan repayments. In addition, if the mortgage interest rate itself is higher because of the higher LTV, the monthly mortgage payments will be higher still. It is important to work out what you can realistically afford when deciding what LTV ratio to target.  

On the other hand, a higher LTV also means that you need a correspondingly lower deposit. So, for example, whilst you will only need a 5% deposit with a 95% LTV mortgage, you will need a 40% deposit with a 60% LTV mortgage. What you can afford as ongoing monthly mortgage payments also needs to be aligned with how much deposit you can afford to put down when planning your house purchase.

FAQs

1. How do I calculate my LTV ratio?

To calculate your LTV ratio, divide the mortgage loan amount by the value of the property and multiply the result by 100. For example, if you borrow £150,000 to purchase a home worth £200,000, your LTV ratio is 75% (£150,000 / £200,000 = 0.75; 0.75 x 100 = 75%).

2. What is a good LTV ratio?

There is no hard and fast rule, but an LTV ratio of 60% or even 75% can usually help you obtain better interest rates and save money over the life of your mortgage compared to higher LTVs.

3. Can I get a mortgage with a high LTV ratio?

Yes, many lenders offer mortgages with high LTV ratios, including 95%. However, these mortgages often carry higher interest rates.

4. How can I improve my LTV ratio?

You can improve your LTV ratio by saving for a larger deposit or choosing a less expensive property with the same deposit. Both options reduce the amount you need to borrow, thus lowering the LTV ratio.

5. Does the LTV ratio affect remortgaging?

Yes, your LTV ratio is important when remortgaging. A lower LTV ratio can help you access better mortgage interest rates and make it easier to demonstrate that you can comfortably afford the monthly mortgage payments.

6. What happens if my property value drops after I buy it?

If your property value drops, your LTV ratio will increase. This can make it harder to remortgage the property.

7. Is LTV the only factor lenders consider?

No, lenders also look at your credit score, employment, income and expenditure, other debts and so on, in addition to instructing an independent valuation of the property itself. However, LTV is a key factor in determining your mortgage terms.

Source

https://www.zoopla.co.uk/discover/buying/understanding-loan-to-value/