Guide to buying property: understanding loan-to-value ratio

The loan-to-value (LTV) ratio is one of the main standard risk indices used by commercial lenders and other financial institutions to qualify mortgage applications. It is a term that expresses the ration of an underwritten loan to the value of the asset bought. If you are looking to purchase a mortgage, it is absolutely important that your understanding of loan-to-value ratio is spot on.

The LTV ratio

Mortgage lenders are especially careful to accurately assess the risk factors a mortgage applicant brings to the table before they approve a mortgage. One of the risk factors that lenders always analyse is the risk of defaulting on loan repayments. To gauge this risk, banks, building societies and other lenders calculate the borrower’s LTV ratio to represent the loan lien as a percentage of the appraised value of the property.

The loan-to-value ratio is calculated as follows:

Loan-to-value ratio = Total mortgage amount ÷ Appraised value of the property

For example, say you borrowed £90,500 to purchase a £100,000 property. Your LTV ratio would be approximately 90.5%. Commercial lenders typically require borrowers to have a maximum of 75% LTV ration to approve a first mortgage. If the LTV ration is higher, loan approval requirements become stricter. In our example, you may find it difficult to get your mortgage approved because your LTV is too high.

LTV ratio considerations

When buying a house, the down payment is a key factor that influences the lending decision. If your down payment is less than 20%, the lender will usually require mortgage insurance. This is because a down payment less than 20% represents an LTV ratio greater than 80%, which means your borrowing risk is too high.

Mortgage insurance coverage will usually come in the form of a fee included in your monthly mortgage payments. It can range anywhere from 0.22% to 1% of your annual mortgage payments, depending on your loan type and specific terms of your insurance coverage. Evidently, understanding your loan-to-value fully will help you pick the mortgage you can afford.

Bottom line

The LTV ratio is not a comprehensive risk assessment criterion for qualifying mortgages. Lenders will have other requirements for you to satisfy before your loan is approved, including a good credit history. Moreover, lenders will review the survey of the land and appraisal of the property in question before approving your mortgage.

As a savvy homebuyer, you should always work to get the lowest risk rating in order to benefit from the best mortgage terms and interest rates. This can start with having a good understanding of loan-to-value ratio and all other factors associated with getting the right mortgage.

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