What Does Loan to Value (LTV) Really Mean?
LTV or loan to value is a term you’ll often hear when buying or investing in property. In this post, I’ll look at how you can benefit from a thorough understanding of what loan to value is and how it is used.
What Exactly is LTV?
Banks and building societies will normally only lend a proportion of what a property is worth. The relationship between what a property is worth and what will be lent to buy it is what the loan to value ratio is.
How to Calculate Loan-to-Value
To calculate your loan to value ratio for any property take the value of the property and subtract the size of the deposit you have towards buying it to find the mortgage you’ll need. Then divide that amount by the value and multiply it by 100 to find a percentage.
This calculator from Which? can quickly calculate LTV for you.
Bear in mind the property value to be used – and this is where some people are caught out when doing their calculations – will be what the lender is likely to value the property at. This isn’t necessarily the same as the asking price or the sale price.
If you are buying a £200,000 property, have a £50,000 deposit, and so, need to borrow £150,000 the LTV will be: £200,000 minus £50,000 = £150,000 divided by £200,000 x 100 = 75%.
But, if you only have a £10,000 deposit, the LTV will be £200,000 minus £10,000 = £190,000 divided by £200,000 x 100 = 95%.
What Kind of Loan-to-Value is Normal?
There’s no ‘golden rule’ for what an LTV should or shouldn’t be.
Check out comparison tables like this one and you will see that most mainstream lenders offer mortgages at in the region of 65% up to a maximum of 85% LTV.
According to UK Finance, the trade association for the finance and banking industry, the average LTV for first-time buyers is currently 84.9% and for home movers, it is 73.4%.
Before the credit crunch of 2008 LTV mortgages of 100% and sometimes more – even up to 120% – were easy to find. While 100% LTV mortgages like this are still available they are now quite rare. However, the number of lenders who offer 95% LTV loans is now higher than at any time since the financial crises – according to What Mortgage..
As an aside, according to the latest UK Finance Mortgage Trend Update, 116,113 mortgages and remortgages were completed last month, amounting to £24.1 billion of lending.
What's Really Important To Know About LTV
Understanding how lenders use LTV to decide and manage their lending policy can often help you get a better deal when looking for mortgage finance.
Lenders generally equate LTV with risk. As a result, LTV normally has a direct impact on the interest rate you’ll pay on your mortgage to account for that risk.
Low LTV loans are seen as safer by lenders: As a result, low LTV mortgages usually have the lowest interest rates.
High LTV loans are seen as having more risk: Lenders consider those borrowing a high proportion of the value of their property are more likely to be stretching their finances, and so more likely to run into difficulties making the repayments.
Lenders are also aware that if property prices fall borrowers with a high LTV loan could actually owe more than the value of the property they have bought. This is known as negative equity. It could mean that the lender will not get back all the money they have lent should it become necessary to repossess the property.
When lenders stop offering high LTV mortgages it can mean that they are pessimistic about future prospects for house price rises (and vice versa).
Normally, the higher the LTV the higher the interest rate they will charge. Also, fewer lenders are willing to lend at higher LTVs (although there are some lenders who actually specialise in high LTV lending). So, the market for them is smaller and less competitive. In some ways, it’s a ‘double whammy’ for those looking for high LTV finance.
Check out this example from The Money Advice Service which illustrates the difference. They say that the average mortgage rate for a two year fixed 95% LTV mortgage is currently 3.99%. Yet the average rate for a borrower who can put down a 25% deposit and so get a 75% LTV mortgage is just 1.70% – and they could fix it for three rather than two years.
In other words, the lender who is considered ‘safer’ is charged less than half the interest rate. A small percentage difference on the face of it, but it could make a huge difference to the interest actually paid.
Not all mortgages are the same, however. Many lenders have different LTV requirements for different types of mortgages. Some lenders have different lending policies for first-time buyers as they know they don't already have a property with equity within it to put towards the new mortgage.
Many lenders have higher LTV requirements for buy-to-let mortgages than they do for standard, residential mortgages as they may consider this type of lending riskier. The Money Advice Services says that buy to let mortgages don’t usually exceed 80% LTV.
LTV has an implication if you are remortgaging too - If you remortgage then your mortgage balance may be smaller as you will have repaid a percentage of your loan. Plus, if property prices have risen in the meantime, you will probably find you are eligible for a mortgage with a lower LTV. That may mean more deals are available at better interest rates than when you took the original mortgage.
A dilemma for investors: It’s worth bearing in mind that LTV can pose something of a dilemma to property investors. Being highly leveraged by using small cash deposits and borrowing a large amount of the purchase price of a property is a way that many investors have used to grow their portfolios quickly – but means that you may only have access to more expensive high LTV finance. To qualify for the best mortgage deals means you may have to work with low LTVs which don’t offer as much leverage. The secret, if there is one, is to find a ‘sweet spot’ between the two points.
What Else LTV Can Tell You
Once you understand how LTV works you can use it to gain some interesting insights about the property market and the pros and cons of different kinds of property investment.
For example, you might think that the most expensive areas to buy property, will have the highest LTVs and are, therefore, potentially the riskiest and that the cheapest areas will have the lowest. But actually, the reverse is normally true.
Property consultancy Savills have produced an interactive map which crunches the numbers on property values and mortgage debts across different parts of the country. It allows you to check out the average LTV in any area you are interested in.
The map also provides some interesting statistics: Savills say that on average mortgaged owner-occupiers have an outstanding loan-to-value of 48%. This ranges from 39% in London to 60% in the northeast of England – despite the fact that the total value of mortgage debt in London is more than six times higher.
Savills explain that owner-occupiers in London have benefited from strong price growth in recent years which has shrunk their average LTV in the process. On the other hand lower levels of price growth in the northeast means the level of debt is much higher.
Savills add that this variation in LTV is even more pronounced when looking at individual local areas. They say that in Burnley (Lancashire) the average outstanding loan to value among owner-occupiers with a mortgage is 88%, but in Camden (London) it is just 15%.