Loan-to-value or LTV, is a tool used to evaluate the risk in a collateralised loan, usually a mortgage loan. It is all about how much mortgage you have in relation to how much your property is worth. It. Or put simply, it is the ratio between:

• Mortgage amount; the value of the loan you take out in order to buy a property
• Appraised value; the appraised value of the property as a whole, expressed as a percentage

Often the appraised value of the property is equal to the selling price but occasionally the bank will require an official appraisal.

When is loan-to-value important?

Loan-to-value becomes a key consideration when you come to buy or sell your property, remortgage or release equity. Loan-to-value is one of the many tools that lenders use to assess the risk inherent in a mortgage. It’s used to calculate how big your loan can be when borrowing funds to purchase a property.

What loan-to-value ratios are available?

Loan-to-value is normally presented as a percentage figure that reflects the percentage of your property that is mortgaged, and the amount that you own (your equity). Lenders set a maximum loan-to-value ratio of x%. This means they will lend you this percentage of the property’s value. The remaining funds need to come from you in your down payment (deposit). Below 80% is considered ‘low’ with 85-90% and upwards considered ‘high’.

What is a good LTV?

As a general rule, the higher the loan-to-value, the higher the risk on the part of the lender. More money is being lent out to someone with less capital to put up front as a deposit. This translates into higher interest rates.

A loan with a lower loan-to-value ratio is less of a risk for the lender and the borrower because less is being borrowed, and so the mortgage will generally be a cheaper product, with less interest.

Of course, other factors will also affect the interest rates you are offered. The type of mortgage you can be granted is dependent on the three main factors listed below. ‘High-risk mortgages’ are given to those who have a poor financial record.

• Credit Score – If you have a poor credit score you are likely to be given a high-risk mortgage.
• Debt-to-income ratio – If you have a high DTI, then you may be given a high-risk mortgage.
• Down Payment – The lower the amount of deposit you are able to pay, the more high risk you will be considered by the mortgage lender.

Because of the risks associated, customers with poor credit histories will generally be offered low loan-to-value mortgages, and high loan-to-value mortgages will be offered to those with much better credit scores.

Why do you want a low loan-to-value ratio?

Typically the higher the loan-to-value ratio, the riskier the mortgage. This added risk increases the loan cost for the borrower via higher interest rates. In these cases, the borrow may also be asked to purchase mortgage insurance.

As a first-time buyer, you may not have a lot of money to put down as a deposit, meaning the loan-to-value you need to afford your mortgage may be quite high. And unless you have an interest-only mortgage (where your balance remains the same throughout the term), your mortgage balance will decrease as you repay it but house prices may change – and this can cause you problems. When a home’s value decreases to below the mortgage balance, the loan-to-value will be greater than 100%. These mortgages are referred to as upside-down.

When taking out a loan, whether or not you’d be better with a higher or lower loan-to-value will depend on whether you place more importance on smaller monthly payments or on a smaller deposit. High loan-to-value means low deposit and vice versa. If you can afford the deposit, a mortgage with a low loan-to-value will work out well in the long run, with lower interest and a lower overall capital value to pay off.

If you have a good enough credit score, as well as the means to maintain the monthly payments, a high loan-to-value mortgage can enable you to get onto the property ladder. Loans with a loan-to-value of 100% are occasionally available but the number of borrowers being offered these and subsequently defaulting on them is thought to be a factor that contributed to the house price crash in 2010.

High loan-to-value mortgages are often the only option for first-time buyers with little upfront capital. However, given the risk involved, many opt to go through housing schemes like help to buy, and shared ownership instead.

It’s important to IMC that clients get to know who is looking out for their financial future. Meet our team and discover our experience to see why we are perfectly placed to provide you financial advice.