July 5, 2011

What does LTV (loan-to-value) mean?

The LTV (loan-to-value) ratio on a mortgage basically describes how much you're borrowing compared with (as a percentage of) the value of the property you're buying.

Sound confusing? It is for a lot of people, but it's actually a lot simpler than you may think. The following chart should help:

Property value Amount borrowed LTV ratio
   £100,000    £90,000    90%
   £100,000    £75,000    75%
   £100,000    £65,000    65%
   £100,000    £50,000    50%

So basically, your LTV ratio describes the percentage of the property's value that you will be borrowing on your mortgage. The rest of the value will be made up by your deposit.

To work out your LTV, use the following simple formula:

(Amount borrowed ÷ property value) x 100 = LTV ratio

Why is the LTV ratio important?
In general, the higher the LTV, the higher the interest rate (and therefore your mortgage payments) will be.

So, let's say you have £40,000 to use as a house deposit. If you put this down on a house worth £200,000, you'd have to borrow £160,000 to make up the difference - which is 80% of the house value. Therefore you'd have access to mortgage deals with 80% LTV.

On the other hand, if you used that £40,000 as a deposit on a £100,000 house, you'd have to borrow £60,000 - just 60% of the value - meaning you'd have access to 60% LTV mortgage deals.

When it comes to choosing a mortgage, you have a choice: borrow more (on a deal with a higher LTV) and you'll probably pay a higher interest rate, or borrow less (on a lower LTV) and enjoy a lower interest rate.

However, this may not always be the case - you may sometimes be able to find a deal with a relatively high LTV that still offers a lower rate than some lower-LTV deals.

Why are higher-LTV mortgages more expensive?
It's basically a matter of perceived risk. A high LTV means the bank is lending you a relatively high proportion of your home's value.

This could cause problems if your home's value drops for any reason. For example, if you have a 10% deposit (90% LTV) and your home's value falls by more than 10%, selling your home wouldn't raise enough money to fully repay the mortgage - so it's simply riskier from your lender's perspective.

This is what people are referring to when they talk about 'negative equity', and it's a problem that has affected many people in recent years. People in negative equity often find themselves unable to get a remortgage, and it can make things much harder for those who want to sell their home.

Mortgages with a higher LTV have become relatively rare in recent years because of this risk (as house prices aren't particularly stable anymore).

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