Loan To Value (LTV) Amounts Explained
The typical method used to finance a property purchase is to apply for a mortgage, particularly if you are a first-time buyer or you only have a small amount of equity built up from previous properties. When applying for a mortgage, the lender will assess an application using various criteria. This will include the applicant’s income, their job status and job stability, their age and health status and their credit rating. But the main factor that is used by lenders to assess the viability of a potential mortgage loan is what is known as the Loan-To-Value (LTV) ratio.
What is the LTV ratio?
A lender uses the LTV ratio as a critical factor in assessing the level of risk in lending to an applicant for a specific property. It shows the lender the ratio between the value of the property on the market and the amount of money the applicant needs to borrow to purchase it. This is expressed as a percentage. Typically, the higher the LTV ratio, the more risk there is to the lender, and the lower the LTV ratio, the less risk there is to the lender.
The LTV ratio is therefore a general guide used by lenders to approve mortgage applications, but it is also a factor in whether mortgage insurance is needed and what repayment interest rate will be set, more on this later. The LTV ratio can also be used as a calculation when assessing the re-financing of an existing mortgage or when borrowing against equity accumulated by an applicant.
How is the LTV ratio calculated?
Calculating the LTV ratio is really simple, and can be done at any stage by the applicant in assessing their chances of obtaining a mortgage and by the lender in assessing the viability of an application.
LTV = Mortgage Amount / Appraised Value of Property x 100
So if the applicant has seen a property worth £200,000 and has saved up a £10,000 deposit, that means they need to borrow £190,000 in a mortgage loan. So:
LTV ratio = £190,000 / £200,000 x 100 = 95%
However, in a slightly different scenario, the same property is still valued at £200,000, but the applicant has been able to save up £50,000 for a deposit or to offer in equity. So:
LTV ratio = £150,000 / £200,000 x 100 = 75%
So the more deposit or capital a borrower can put down, the lower the LTV ratio will be. Generally speaking this will increase the chances of a mortgage lender approving the loan application, because the risk to them is less.
It is important to note that the property value used in the LTV calculation is the ‘appraised’ value, not the final price paid by the borrower. This is because the mortgage lender is only interested in the market value of the property. It could be that the borrower ended up negotiating a price of £190,000 for the property that was originally valued at £200,000. This is great for the borrower, but the seller’s personal circumstances and why they knocked £10,000 off the value are of no concern to the mortgage lender. If the borrower defaults on the mortgage payments and the property needs to be re-sold by the lender, they want to know what the actual market value is. That will hopefully still be £200,000 or higher, not the £190,000 the defaulting borrower ended up paying.
What is a good LTV ratio?
This very much depends on the applicant’s personal circumstances and the attitude to risk of the lender, but generally speaking, the accepted criteria is that any LTV ratio of 80% or above is considered to be a high LTV, and anything less than 80% is considered to be a low LTV.
So an LTV of 80% or lower is ideal. This is an unwritten benchmark for LTVs, because with many lenders it will trigger the need to enforce Private Mortgage Insurance (PMI). An LTV ratio of 80% or above may require the applicant to take out PMI to offset the increased risk undertaken by the lender.
The figure of 80% is also typically used as the benchmark for setting repayment interest rates. So a loan with an LTV ratio of less than 80% may be offered a lower interest rate, and a loan with an LTV of 80% or above may be offered a higher interest rate. Again, this is because the lender has to protect themselves against the risk of the borrower defaulting on the mortgage repayments.
Why is the LTV ratio important?
A high LTV ratio doesn’t automatically mean that a mortgage application will be rejected, but it presents a different scenario to both the lender and the borrower. So the importance of the LTV needs to be considered in both contexts.
To the lender
If the LTV ratio is 80% or above there is a higher chance of the borrower defaulting on their mortgage repayments because they are too big a commitment.
If the market value of the property is good, then there is a better chance of the mortgage lender getting their money back, or even making a profit, should they need to put the property back on sale.
The LTV ratio enables the lender to make calculations relating to interest rates, in order to offset the exposure to risk and manage a situation to minimise potential losses.
To the borrower
The borrower can assess their chances of being successful with a mortgage application when weighing up whether to make a bid for a house, or whether they are ready to enter into the property market at all.
The LTV ratio enables the borrower to assess what kind of deposit they need to save up. The higher the deposit down payment they can make, the lower the LTV ratio will be.
The lower the LTV ratio is, the less chance the borrower will face extra costs in PMI and higher interest rates.
Considerations when looking at the LTV ratio
Combined LTV: When assessing a mortgage application, the LTV ratio doesn’t take into account any other financial obligations the borrower has, or any other factors that may influence their ability to repay the mortgage. Some lenders may use a combined LTV (sometimes known as the CLTV) which takes into account factors such as a second mortgage or outstanding loans for other purposes. These are all important commitments which add to the mortgage being applied for, and therefore, the financial pressures on the borrower. So going back to our earlier example; a £150,000 mortgage on a £200,000 property might give a 75% LTV, but if you add an outstanding second mortgage of £30,000 and an outstanding loan of £10,000, you are effectively back at a 95% LTV ratio.
**Calculate LTV any time: **It is possible to calculate the LTV ratio at any time during the mortgage term, not just at the outset of the loan. So the borrower would subtract the mortgage repayments already made and adjust the market value of the property (ie. whether it has gone up in value or down in value) to give an accurate LTV at that moment in time. The property value is perhaps the biggest factor here in whether the LTV has gone up or down. Calculating the LTV during the mortgage repayment period would be useful if the borrower was looking to re-finance the mortgage or borrow more money against the property.
**LTV used for other loans: **A lender can use the LTV calculation for any kind of high value loan, because the simple principal works in the same way to assess the exposure to risk. So an LTV calculation also works for vehicle finance or a loan to buy a new kitchen, or to finance an extension, for example.
**What is a good LTV ratio for me? **
In simple terms, most people want an LTV ratio as low as possible, but that isn’t always easy to achieve. There are two main ways that you can lower an LTV ratio on a potential property purchase; by increasing the deposit down payment you can make, or by opting for a cheaper property than the one you were originally looking for. This is often the scenario faced by first-time buyers or people with very little equity built up in the property market.
If you can only afford a low deposit, then you will most likely face a higher LTV ratio. This doesn’t mean you won’t be approved for a mortgage, but you will probably face higher costs in terms of your monthly repayments, and these may also include PMI and higher interest rates. This is a big commitment, but on the flipside, it gets you onto the property ladder as quickly as possible, and without having to jump through too many hoops.
A more experienced borrower, ie. someone higher up on the property ladder, or simply someone who can afford a much bigger deposit for whatever reason (maybe investing an inheritance or enjoying a moderate lottery win!) will, in return, most likely face a lower LTV ratio, lower interest rates and a lower overall capital to pay off. This is a favourable situation to most of us, but is harder to attain, mainly by people with a few years of savvy investment or saving behind them.
For the first time buyer, the best way to establish a lower LTV ratio and a more affordable mortgage is to be more patient in saving a bigger deposit, or to compromise on the quality of property. To many people in a very challenging property market, that is a reality that is worth waking up to.