Understanding loan-to-value

Understanding loan-to-value

By Nic Hopkirk

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If you're thinking of buying a house and applying for a mortgage, you'll need to know all about loan-to-value. Here's our guide with the lowdown.

What does loan-to-value mean?

If you’re thinking about buying a house and applying for a mortgage, you’ll hear about loan-to-value a lot. It’s usually called LTV for short. 

But what does loan-to-value mean and why does it matter?

Loan-to-value is the amount you’re borrowing for a mortgage, expressed as a percentage of the property’s total value.

It’s one of the main things banks and building societies look at to decide what rate they should charge you on your mortgage. 

They need to make sure you’ll be able to pay back the amount you borrow. So they look at what you earn and spend to decide what you can afford.

But they also take your deposit, the amount you want to borrow, and the value of the home into account. 

That’s where loan-to-value comes in.

Why is loan-to-value important to mortgage lenders?

The higher your loan-to-value ratio, the riskier it is for the lender to give you a mortgage.

If you’re buying a £250k house, the lender would rather give you £200k (80% LTV) than £225k (90%).

So if they need to lend you 90% of the property's value, they’ll charge you higher rates to make sure they’re protected.

How to calculate your loan-to-value ratio

Let’s say you want to buy a house worth £200k. You’ve saved a deposit of £25k.

That means you’ll need a mortgage of £175k. 

To work out your LTV, you divide the mortgage amount by the total value, then multiply it by 100.

£175,000 (mortgage) ÷ £200,000 (total house value) = 0.875

0.875 x 100 = 87.5

Your LTV is 87.5% because your mortgage is 87.5% of the home’s value.

Victorian terraced houses

What is equity and how does it affect your loan-to-value?

Your equity is the value you have paid off towards your house, whether that's in your deposit or mortgage payments.

In the example above, you’ve got £25k equity because that was the size of your deposit. 

As you pay off your mortgage, your equity in your home will increase. 

(Your equity also increases if your home goes up in value, but we’ll come onto that later).

How to work out your equity in your home

Mortgage lenders usually use a percentage to describe equity.

Let’s say you’ve lived in your £200k house for 5 years. (Let’s assume it’s worth the same as when you bought it.)

You paid a £25k deposit when you first moved in. And you’ve been paying your mortgage every month, so you’ve paid off another £50k.

Your equity has increased to £75k. That’s your deposit plus the amount you’ve paid back to the mortgage lender.

To understand your equity as a percentage, divide the money you’ve paid off by the total value, then multiply by 100.

£75,000 (equity) ÷ £200,000 (total house value) = 0.375

0.375 x 100 = 37.5%

Your equity has increased to 37.5%.

And your loan-to-value has dropped to 62.5%.

How loan-to-value affects mortgage repayments

Most banks and building societies classify mortgages into different LTV bands. 

If you have a high LTV, you’ll be charged the most interest.

The general rule of thumb is that you’ll be charged:

  • the most interest for an LTV of 90% or higher
  • less interest for an LTV of 75%
  • the least interest for an LTV of 60% or lower

What is a good loan-to-value ratio?

In general, 80% and lower is considered a low loan-to-value. You’ll have access to better mortgage offers and cheaper interest rates.

Anything above 80% is considered high.

First home buyers tend to have a loan-to-value of more than 80% as they haven’t built up any equity.

How to improve your loan-to-value ratio

To improve your LTV, you need to make the gap between your deposit (or equity) and the house price smaller.

There are 3 main ways you can improve your LTV.

1. Save a bigger deposit

One way to improve your LTV is to wait until you have a bigger deposit before you buy.

Check out our different ways to save for a deposit.

Although you might not want to wait, a bigger deposit means a lower LTV. That means more manageable monthly repayments and lower interest rates.

2. Negotiate a lower price when buying a home

If you can bring the price down on the home you’re buying, you'll have a lower LTV.

You could make a cheeky offer, or negotiate a lower sale price with the seller. Or you might think about searching for cheaper houses for sale.

3. Improve your home’s value

In the current property market, most homes are gaining value. Check if your home’s gained value since you bought it.

You can find more ways to add value to your home, from redecorating to converting and extending.

If you can help your home's value go up, you'll be helping your LTV come down at the same time.

4. Keep paying off your mortgage

It sounds obvious, but paying your mortgage each month is improving your LTV.

As you keep making payments, you own more and more of your home. Your equity grows and your LTV drops.

Loan-to-value for first-time buyers

If you're a first time buyer, you might've been saving for years to get a deposit.

If you have a deposit of 10% or 20% of the home's value, you'll have a relatively high loan-to-value ratio.

This means the bank won't offer you the best deals and you might have high interest rates.

But, after a few years of paying off your mortgage, you'll bring your LTV down. You should be able to remortgage at a lower rate somewhere down the line.

It might be tempting to step onto the property ladder as soon as you have a minimum deposit together.

But it's worth considering if this makes the most sense in the long run.

The larger deposit you have, the lower your LTV. This means a better mortgage deal and lower interest rates, which can save you a lot of money over the years.

You'll come across lots of extra costs in the home-buying process, too - from legal fees to stamp duty (although you might quality for a stamp duty break). So it's important to factor these costs in.

There's a mortgage guarantee scheme, which means you only need a 5% deposit to buy a home. You can borrow the remaining 95% of the property’s value.

Designed to help would-be homeowners with smaller deposits step onto - or climb up - the property ladder, the scheme is open to new applications until 31 December, 2022.

Check out our complete guide for first time buyers for more advice and support for getting on the property ladder.

New build detached house

Calculating your loan-to-value as house prices change

This is where working out your LTV gets a little more complicated. 

You'll be paying off your mortgage at the rate you agreed when you bought your home. But the value of your home might be changing.

How do rising house prices impact your loan-to-value?

The average price of a home in the UK has historically risen over the years. It means a £250k house that you bought several years ago could now be worth £350k, or even more.

Let's say you bought a £250k house five years ago.

You put down a £50k deposit and got a £200k mortgage to cover the rest. At the time, your LTV was 80%.

You've paid off £50k of the mortgage with your monthly payments, so now owe the bank £150k.

But over the same period, the value of the property has risen to £350k.

This means you now own 57% of your property and your loan-to-value has dropped to 43%.

How do falling house prices impact my loan-to-value ratio?

House prices can go down as well as up.

If you take out a mortgage with a high LTV on the assumption that your home will increase in value, you could be caught out.

Let's say you bought a home for £500k with a £50k deposit. Your LTV is 90%.

If the value of the property went down to £400k, you would owe more on the mortgage than the property is worth. 

It would make selling your house difficult because you’d still owe the bank £50k if you did.

Being in negative equity can make it difficult to remortgage to a more favourable rate too. Mortgage providers will never lend more than what they think a property is worth, so it's not a good place to be.

Stone house blue windows

How does loan-to-value affect remortgaging or moving house?

Loan-to-value is just as important a consideration for people moving house, or remortgaging an existing property.

The amount of equity you hold in your property will affect your ability to remortgage, and may limit your options.

If you have been paying off your original mortgage for several years, and house prices have gone up or remained stable, you will have more equity.

That means you’ll be able to take out a new mortgage with a more favourable loan-to-value ratio, and possibly much lower interest rates than you did before.

However, if house prices are currently going through a low point, and there is no urgent need to move, it may make sense for you to stay where you are for a couple of years.

Find out more about how mortgages, repayments and interest rates work in our mortgages section.

How mortgage brokers can help

Although you may be wary of spending yet more of your hard-earned cash, it can often pay to use the services of a mortgage broker.

They are a qualified professional who has arranged hundreds of other mortgages, understands the industry, and knows what’s currently on offer. 

Using a broker will not necessarily cost you more money. Whatever fee they might charge is often much less than the savings they help you make.

Some have access to 'broker exclusive' deals that are better value than those available direct from a mortgage provider.

A broker will also be able to advise you on the type of mortgage to take out, and on effective ways to maximise your assets, and save yourself the most money. 

Here's how to find a mortgage broker you can trust.