Equity and loan to value explained

If you’re thinking about buying your first house or currently looking to remortgage, you’ll hear about equity and loan-to-value (or LTV) a lot.

Current homeowners may need to consider their current equity and LTV when looking for a new mortgage deal. This is because lenders use LTV to assess the risk of a mortgage, therefore a lower LTV can unlock a better mortgage deal, such as lower interest rates and smaller monthly repayments. 

Equity is the value of your home, minus what’s left to pay on your mortgage.   

Your equity increases if the value of your home increases and as you pay off your mortgage. It can also go down if the value of your home goes down.   

You can use your equity as a deposit to put towards your next home.

Loan-to-value (or LTV) ratio is a way of measuring how much you’ve borrowed for a property from your mortgage lender, compared with its value. This is calculated as a percentage.

Mortgage lenders use your LTV and equity to decide what interest rate they offer you. The lower the interest rate, the less you have to pay back. Lenders divide their interest rates into loan to value bands. 

The lowest band tends to be 60% and it goes up in 5% increments to 95% LTV. Being part of a lower band usually means lower interest rates.

Example 1: You bought a property, your LTV is 90%

Let’s say you bought a house worth £350,000 and you paid a 10% deposit of £35,000. The loan (or mortgage) on the remaining value of the house would be £315,000 or 90% of the total house value meaning your loan to value is 90%.

Example 2: You’ve paid off some of your mortgage but the property value remains unchanged

Let’s say you’ve lived in the house for a few years and you’ve been making monthly mortgage payments paying off the mortgage (as well as the interest). In this example, the value of your house has remained the same (though this often changes). You’ve paid off £52,500 of your original mortgage. With your original deposit and mortgage payments, you’ve reduced your outstanding mortgage balance to £262,500 or 75% of the total house value meaning your loan to value is 75%.

Example 3: Your property value increased without paying off your mortgage

Let’s say you bought a house worth £350,000. Shortly after, a new train station was announced to be opened in the local area increasing the value of your house to £393,500. In this example, the value of your house has increased however you’ve not paid off any of your original mortgage. With your property value going up, your original outstanding balance has remained the same however your equity has increased to £78,500. This reduces your loan to value to 80%.

To improve your LTV, you need to increase your equity. This can happen for one (or both) of the following reasons:

You can access a number of tools that can help you understand your equity and LTV when you connect your mortgage in Monzo. Use our overpayment calculator to help you understand whether making any additional payments on your mortgage can help you reduce your mortgage debt enough to potentially move into a lower LTV ‘band’. 

Example:

Let’s say you’ve bought a property and agreed with your lender to pay £900 a month on your current mortgage deal. Your £900 monthly mortgage repayment pays off the interest owed on your mortgage as well as your loan amount. 

Scenario A: Making regular payments on your mortgage

In this scenario, you decide to make the agreed regular monthly repayments of £900 until the end of your current deal. You may not pay off enough of the mortgage loan to move to a lower LTV band and be offered a better interest rate when you remortgage.

It’s worth noting that if your property value has increased, then your equity will increase and you may be able to move to a lower LTV band. If your property value has decreased, then your equity may decrease and you may move to a higher LTV band.

Scenario B: Making a regular overpayment on your mortgage

In this scenario, you can afford to pay an extra £100 on top of your agreed monthly mortgage repayments of £900. You’re now paying £1000 per month. Over 5 years, this extra monthly overpayment pays off an additional £6000 of your loan amount. This might be enough to help you reach the next LTV band and be offered a better interest rate when you remortgage.

It’s important to note that property values go down as well as up. This means overpaying your mortgage isn’t a guarantee on reaching the next LTV band.

We’ve got more blogs about the remortgage process and different types of mortgage.