If you’re looking to purchase a property in the UK, then chances are the first thing you’ve thought about is getting a deposit together. The days of being able to purchase a home without having to put down a deposit are long gone, with typical deposits now coming to tens of thousands of pounds.
However, simply having a deposit isn’t enough. You’re also going to have to think carefully about the loan-to-value (LTV) of the mortgage you arrange.
Loan-to-value: what does it mean?
LTV basically means how much your mortgage is worth compared to the value of the property. So for example let’s say you wanted to buy a house worth £200,000 and had saved a deposit of £20,000.
You’d need a mortgage of £180,000 in order to complete the purchase, which is 90% of the value of the home. Therefore you’d need a 90% LTV mortgage.
Why does the LTV matter?
Put simply, the higher the LTV is, the more expensive the mortgage is going to be.
It all comes down to risk - if you are putting down a sizeable deposit, then lenders view you as a less risky proposition than someone who can only get together 5% or so of the purchase price.
For example, if you wanted to take out a mortgage at 60% LTV today - in other words, you have a 40% deposit - then you could get a two-year fixed rate at as low a rate as 1.38% from Skipton Building Society.
But let’s say you needed a 90% LTV deal as you only had a 10% deposit. Now the best deal available to you is 1.79%.
That might not seem a big difference, but in practice it means a noticeable change in the size of your repayments. Borrow £150,000 over a 25-year term at a rate if 1.38% and you’ll have to make monthly repayments of £591. But if that rate is 1.78% then your repayments jump to £621 - that’s an extra £360 a year.
Avoiding negative equity
Negative equity is where the outstanding mortgage is worth more than the value of the property.
Let’s say you bought that £200,000 house we mentioned earlier with the £180,000 mortgage. If house prices fall sharply then a year or so down the line the property might be worth £150,000, but the mortgage you still owe will be significantly more than that.
This is a problem if you want to sell and move to a new house, as the money raised from the sale won’t be enough to clear the mortgage, let alone put down a deposit on a new place. Remortgaging will also become difficult.
You basically have a couple of options when it comes to negative equity - either reduce the size of the mortgage or increase the value of the property.
Your mortgage will obviously fall in size over time as you make your monthly repayments, but it’s worth remembering that most deals allow you to overpay by up to 10% a year without hitting you with any additional charges.
If you want to go down the route of improving the value of your property, then you might need to look at home improvements. A study from GoCompare this year flagged up things like installing a new boiler, giving the garden a make-over and knocking through rooms as some of the most successful home improvements if you’re looking to increase the value of the property.