De-mystifying Loan To Value
LTV is one of those acronyms that is thrown about so frequently by mortgage brokers that it can be very hard to remember that not everyone knows what it means. It is probably the most important factor in mortgage lending, so I wanted to explore what LTV means and why it’s so important.
LTV means ‘Loan to Value’. It is the ratio between the loan amount being borrowed and the value of the property that loan is being secured against. Typically, lenders issue a selection of interest rates and fees broken down into Loan To Value ‘bands’. LTV is represented as a percentage and generally starts at around 60% but can get up to 90% or 95% LTV. Lenders use the LTV as a measure of how risky a mortgage will be. If you are borrowing 95% of what the house is worth, then you have a relatively small stake in the property. If things don’t go to plan, the mortgage doesn’t get repaid and you disappear into the sunset, you would stand to lose very little in comparison to the huge amount the lender might lose. In fact, at 95% LTV, as well as factoring in estate agency and solicitor fees, you might think it better to let the home be repossessed than try to sell the property yourself (if we ignore for a minute the severely negative consequences to your credit file). Mortgage lenders will always be looking out for these worst case scenarios and will expect at least some of their customers to go down this path. This is why they separate their products by Loan to Value; lenders need to charge those with a riskier deal more to compensate for the fact they are likely to lose out on some of them.
Of course, this is an example of a worst-case scenario. Few of us would consider entering into the house buying process if we thought we couldn’t afford to maintain a mortgage, but lenders will always be expecting the worst-case scenario. These days, repossessing a house is not an eventuality that the lenders want to entertain. The FCA (Financial Conduct Authority), tasked with ensuring another property crash won’t happen again, require that lenders take great care in making sure customers have stable and realistic methods of paying off their mortgages, so that repossession is the absolute last case scenario.
However, affordability is always going to be a factor, and LTV ties in very heavily with how his is assessed. Talking to one of the biggest asset management companies (companies responsible for valuing, marketing and selling repossessed properties on behalf of the banks) I was once told that, on average, the lender only gets about 85% of the value of the loan when a property is repossessed. The reason for this is that repossessing houses is very expensive. Court fees need to be paid, bailiffs instructed, solicitors, locksmiths, asset managers and estate agents all need to be involved. This is why lending at 95% or even 90% is still very difficult as lenders know that for each of these loans that cannot be repaid, they may lose 5 to 10% of the loan amount.
Contrast this with someone who is able to put down 40% of their cash for a property and all of a sudden it is the customer who has the most to lose should they fail to make repayments. If a lender repossesses and then sells the property, there is a very good chance the lender will recover everything that was owed. The customer would be the one paying for the cost involved in selling the property. In addition to this, the property will be sold for a 30-day price, in other words a price that would expect to attract a buyer within 30 days. This could be significantly less than if they were able to wait for the best offer. This practice in itself is not terribly helpful to most people, because we have finite amounts of money. With prices rising again, we often feel like we have to grab the best property we can as soon as possible before the value of the deposit needed is diminished.
If you are selling a property, however, the price achieved can play a huge role. Common LTV thresholds tend to be in 5% increments up from 60% through to 95%. If you know what you need to spend to get the next home that you want, you can work backwards and calculate the very least you can accept for your current property to ensure you get into one of the lower LTV bands. If interests rates differ by, for instance, one percentage point on a typical mortgage of £150,000 over 25 years, the cost could mean a difference of about £82 a month. It would be very frustrating if you were only a fraction over the required Loan To Value threshold so is essential to have an understanding of where you would fit within them.
The Loan To Value is also crucial when considering remortgaging your property. It can be very difficult to judge the correct value of a property for a remortgage because no transaction taking is place. After all, a home is only worth what someone is prepared to pay for it and so remortgage valuations are difficult to judge. Sometimes a property can be valued much lower than expected simply due to few other properties in an area having been sold. This makes it very hard for the surveyor to estimate it’s value. In this case you need to be cautious as you may choose a lender that has the best deal at 75% LTV, but their rates may be poor at around 80% or 85%. But, once you have paid valuation or booking fees and completed the application process, it could be costly to have to reapply to a different lender. For this reason it’s well worth finding a lender that offers acceptable rates across the LTV thresholds you might end up in so you don’t have to reapply if the valuation comes back lower than you expect.
Your home may be repossessed if you do not keep up repayments on your mortgage.
A good blog! I will bookmark a few of these..