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When lenders are assessing loan applications secured for most property types, one of the major components they consider is what is known as Loan to Value or LTV. These calculations and ratios are a key component in their due diligence and decision making process but are also used for both first and second mortgages for commercial loans, bridging finance, and even residential properties.
Although LTV is a common toll for lenders, many applicants and borrowers are in the dark as to what LTV is and lack a true understanding of how lenders use this calculation in terms of their financial assistance.
How Loan to Value Relates to Risk
Loan to Value is the calculation of how much mortgage a borrower owes in relation to the estimated value of their home or property. As part of an example, let us evaluate a borrower who has a mortgage of £100,000 for a home that is worth £200,000.
Based on these valuations, that borrower’s Loan to Value is 50 percent and they, in theory, have equity of £100,000. Lenders look for the lowest LTV possible because it directly relates to the risk the lender will take by approving the loan. When the LTV is low, lenders are more confident that payments will be made consistently through the life of the loan.
When an applicant is requesting to borrow money against their currently owned property, which in turn releases some of the equity from the property, the Loan to Value percentage that lenders consider appropriate changes. In this situation, lenders are comfortable approving loans at an LTV of 75 per cent, that is, three-quarters of the property’s value.
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The maximum LTV allowed for second mortgages or second charge on a home is currently 90 per cent – when it comes to bridging loan terms, however, the accepted Loan to Value for many lenders remains at 75 per cent.
Do Lenders Look at Applicant’s Credit Scores?
While Loan to Value percentages are important for gauging risks, there is other information that lenders evaluate and consider when assessing a loan application. A lender will also investigate an applicant’s credit score to help paint a better picture of borrowing habits and what the individual’s repayment history looks like on other loan types such as credit cards and car payments.
Although some applicants may not have the best credit score, it should not stop them from securing financing – usually, when an individual has a low LTV they are still considered for the loan even with the not so perfect credit score.
How Loan to Value Calculations affect Bridging Loan Interest Rates
Loan to Value percentages do not only help lenders make educated decisions on risk, they are also a deciding factor in short-term loan or bridging loan interest rate calculations. Interest rates for these types of loans are again based on the lenders overall risk for providing the financing to an applicant, basically to cover themselves if the loan should go into default.
When an applicant presents a low Loan to Value percentage, their interest rates tend to be lower as well since they present a smaller risk. When there is a high LTV percentage, lenders consider this a higher risk and often charge higher interest rates.