If you’re thinking of borrowing money - whether it’s for a new home, mortgage, car, or something else - you’ll need to understand how loan-to-value ratios (also known as LTVs) work.
In this guide, we'll explain what LTVs are, why lenders use them, and how they’re calculated. We’ll also answer important questions like ‘what is a good loan-to-value ratio?’ - so you can feel better informed when talking to your lender.
At Salad Money, we calculate risk differently. Instead of credit scores, we use Open Banking. This is a system that lets NHS and public sector workers safely share their banking transaction information, this then allows Salad to have a better understanding of their financial position by looking at the here and now. To us, this makes more sense than basing our decisions entirely on an outdated credit score.
Learn more about Open Banking and apply for a loan with us today - we can have the money in your account by 12pm the next day.
What is loan to value ratio?
Lenders use loan-to-value ratios to work out how much risk they’ll be taking if approving a secured loan. Also known as an LTV, this process compares the market value of an applicant’s asset (for example, a car or house) to the total loan amount.
This is a risk reduction exercise. Because the loan is offset against an asset, the lender will be able to recover some of its losses if the person borrowing from them defaults on their repayments.
Put simply, the higher the LTV, the higher the risk from the lender’s perspective - meaning the application is more likely to be declined. If the loan-to-value ratio is lower, the creditor may offer more favourable terms - for example, lower interest rates.
LTVs aren’t just used for secured loans. They’re employed by lenders to qualify or reject applications that present a high level of risk in cases where the total loan amount is very high (for example, a mortgage).
How do you calculate loan to value ratio?
If you decide to borrow money to buy a new car, renovate your home, or something similar, your lender will divide the amount you want to borrow by the total amount of the loan - then multiply that figure by 100%.
If you decide to buy an car with a retail price of £20,000 but have a deposit of £5,000, you’d need a loan of £15,000. To find out the LTV, your lender would run the following calculation:
(£15,000/£20,000) X 100 = 75%
Therefore, your loan-to-value ratio would be 75%.
How do you calculate loan to value ratio on a mortgage?
So, how will your lender calculate your LTV? The calculation they’ll use is surprisingly simple. The total loan amount is divided by the value of the asset. This figure is then multiplied by 100 to give a percentage.
What does 60% LTV mean?
Here’s an example of how an LVT works in practice. Imagine you want to purchase a property worth £500,000 and you have a deposit of £200,000 to give your lender. This leaves a total loan amount of £300,000.
Your lender will therefore run the following calculation:
(£300,000/£500,000) X 100 = 60%. This percentage - in other words, everything except your downpayment - is the LTV ratio.
As you can see, the process for calculating the loan-to-value ratio for a mortgage is the same as with a standard loan.
Will my loan-to-value ratio stay the same?
An LTV matters most at the point of application. However, your provider may review that ratio later. They will do this by dividing how much you owe by the appraised market value of your home.
Why do they do this? As you repay your loan, the amount you owe (and, therefore, the loan-to-value ratio) shrinks. But fluctuations in the housing market could cause the value of your home to change.
By reviewing the LTV on a mortgage, a provider can assess potential risk. For example, if the market value of your home exceeds the balance of your loan, you will go into negative equity and your lender might impose higher closing costs if you repay early.
Lenders may choose to do this with other types of loans - such as car financing schemes. A vehicle can depreciate just like a house, which means it could become worth less than the total balance of your loan. Should this happen, you’d need to pay the difference if closing the loan early.
What is a good loan-to-value ratio in the UK?
The higher the LTV, the more risk you present to your prospective lender . That’s because they’re giving money to someone with a smaller deposit. Expect to pay more interest if your loan-to-value ratio is especially high.
Contrastingly, if your loan-to-value ratio is low, your lender will view your application more favourably - as you won’t be borrowing as much. In other words, the object of your loan - be it a house or car - will be cheaper. So, the lower your LTV, the better!
Your credit score will be taken into account
A low LTV alone won’t guarantee a better interest rate. Your lender will also consider your credit score - which could have a positive or negative effect on your application (depending on how good you are at balancing credit and spending).
Is a higher or lower LTV better?
The answer to the question ‘what is a good loan-to-value ratio?’ depends on individual priorities. If you want to pay less each month, you’ll need a sizable deposit. Alternatively, you can decrease the size of your down payment if you’re not worried by larger monthly repayments.
Lower is the better way to go
A lower loan-to-value ratio means you’ll be paying lower costs for the lifetime of your loan. It also makes you less of a risk to your lender - because your instalments will be smaller and, therefore, more manageable (in other words, you’re less likely to miss payments).
Mortgages with higher LTVs often attract first time buyers. In many cases, these borrowers take out loans with a loan-to-value ratio of 100% - sometimes higher. But this is a high risk game to play and can lead to applicants defaulting on their loans.
If you are a first-time buyer trying to get on the property ladder - and have little or no capital - a help to buy housing scheme is less risky and worth exploring.
To decrease your LTV:
Modify the object of your loan by compromising and buying an older or smaller home that’s less expensive
Save up more money, so you have a bigger deposit to give your lender - thereby shrinking your monthly repayments
Salad Money: An alternative to conventional borrowing
LTVs are usually calculated using your credit score. Our approach is different. We specialise in offering short-term loans to NHS and public sector workers who might otherwise struggle to borrow.
As we mentioned at the beginning of this guide, we assess applications using Open Banking - a system that allows you to give us access to your financial information (such as bank statements), to make a more informed assessment of your financial position. .
Open Banking is secure and regulated by the FCA. You can also withdraw your consent at any time. Apply now or contact a friendly member of our team with any questions you have.