So if you borrow £180,000 in order to buy a home worth £200,000, the LTV is 90%. You are borrowing 90% of the value of the house. You would provide the remaining 10% – £20,000 – in the form of a deposit (or home equity, if you’re remortgaging or moving house).
As a general rule, the higher the LTV, the more expensive your borrowing costs will be. The cheapest mortgages tend to be on LTVs of 60% or lower. This is because lenders consider people requiring high LTVs as being higher risk.
For starters, if you can afford to buy only a small percentage of the property upfront, you are not considered as safe a bet as someone who has a larger pot of money to play with.
And in the worst-case scenario of the lender needing to repossess the property, it will have far less chance of recouping its money if it already owns almost all the property. On the other hand, if the lender repossesses a house that has a 70% LTV mortgage, it is far more likely to be able to recover all its money when the property is sold.
The cheaper interest rates that come with lower LTV loans can save you a fortune. Although a fraction of a percentage point might look like mere detail, a slightly lower rate can save you tens of thousands of pounds over the course of the mortgage term.
In short, if you have a low LTV, the mortgage lender is taking less of a risk – and they reward that lower level of risk by giving you a preferential interest rate.
For example, if you have borrowed £190,000 to buy a £200,000 property (95% LTV), and then the value of the property goes down and you can’t keep up repayments, there’s a chance that the lender won’t get all of their money back. The mortgage lender hedges this higher level of risk by making you pay more interest.
If you only need a mortgage of £150,000 to buy that same £200,000 property (75% LTV), there’s a lot more wiggle room: the bank might be able to sell your home and make back most or all of its money.
Not all lenders offer loans at every LTV level. Most will offer a range of two or three LTV bands – perhaps between 80% and 95% LTV, between 60% and 80% LTV, and below 60% LTV, for example.
There are two ways to reduce your LTV: saving up a larger deposit or reducing the amount of money you need to borrow.
If you’re close to an LTV threshold – say you need to borrow 91% of the purchase price, for example – try to cobble together a slightly higher deposit or see if you can negotiate a slightly cheaper price on the property. If you can manage to get your borrowing requirement down to 90% of the purchase price, you could be eligible for a cheaper range of mortgages.
The other option is more brutal: try to find a cheaper home. This might not be the message you want to hear but it might be the sensible option in terms of your finances.
It’s no fun being financially stretched and struggling to make ends meet, and the disappointment of having to aim slightly lower down the housing ladder now is a lot less than the anguish you’d suffer if things went sour with your dream home further down the line.