LTV (Loan-to-Value)

If you’re thinking of buying a house this is a term you’re going to have to deal with. The Portuguese financial system (supervised by the Bank of Portugal) has been implementing several criteria regarding credit approvals, thus allowing families to obtain sustainable financing whilst preventing banks taking excessive risks.

LTV is an acronym that means Loan-to-Value. The loan to value is a ration, expressed in % tha measures the amount financed in comparison with the acquisition value of a property or the valuation value of the same property.

LTV (%) = Amount Financed/Property Value

For example, if a property cost €150,000 and the financed value is €112,500 the LTV is 75%, calculated as follows:

LTV(%)=112.500€/150.00€=75%

Why is LTV important? How can it influence the decision to approve your mortgage?

LTV:

  1. It is determinant for the spread that will finance the property;
  2. LTV results from the acquisition value or valuation value (whichever is lower)
  3. LTV depends on the effort rate of the applicants.

Concerning the first situation, LTV is one of the factors influencing the proposed spread for housing loans  (see also related articles:  spread (mortgage perspective)). The greater the LTV the larger should be the spread because risk to the financial entity is also higher.

Between the following operations which represents a higher risk to the bank?

  1. A credit of €200,000 backed up with a property valued at €800,000, or
  2. Finance 90,000€ for an apartment that was acquired by €100.00.

If you replied 2) then your answer is correct.  Note that in the first operation the LTV is 25% while in the second it is 90%, so it is riskier. In a possible adverse movement of the market value of the property the operation in 2) is more likely to fail although in absolute terms the value of the loan is lower (for the purposes of this exercise we are not assessing the profile of Client).

Regarding the second situation, Bank of Portugal defends that certain LTV ratios should be met according to the country of residence, the origin of income and the nationality of the applicants. For Portuguese citizens, whose income is from and country of residency in Portugal the recommended LTV are as follows:

  • New loans to permanent own housing (whether construction or acquisition) the maximum LTV is 90%
  • Housing credits with other purposes (e.g. investment or secondary home) The maximum LTV is 80%
  • New housing credits whose property is from the institution itself (also known as banking property) The Maximum LTV is 100% of the published value.

Although Bank of Portugal recommends these LTV´s does not mean that the credit institution where you may intend to mortgage will do so. There are banks whose credit granting policy is NOT TO practice LTV higher than 80% regardless of purpose. So get some information prior to taking commitments, particularly if you haven’t a Portuguese nationality or your income is obtained abroad.

We emphasize the fact that LTV is calculated according to the lowest value between the acquisition amount and the valuation amount. In many cases they don’t have the same value.

Suppose John and Mary want to buy an apartment that’s for sale for €100,000. Both can put-in out of their pocket a maximum of €13,000. We are assuming that they have €10,000 for down payment and €3,000 for expenses (IMT, duty stamp financing and acquisition, costs of notaries and bank commissions).  They signed a promissory note and paid 10% of the property. Later, after the approval of the bank loan. Later they had their house appraised for €94,000.

Since the maximum LTV maximum is 90% the finance value is now €84,600 and not €90,000 as originally John and Mary had thought. This can cause a problem if both cannot obtain the remaining amount of equity and may eventually lose the down payment.

Finally, the third situation is related to available income and the effort rate.

Let us imagine that the bank credit scoring is referred that the borrower’s effort rate cannot exceed 35% of the income.

Taking the example of the second situation and if John´s and Mary´s available income is 1,000€ net/month then the monthly installment could not be more than 350€.

Using the interest rate of 1.5% annually and a period of 30 years then the maximum amount that could be financed is €102,000 (corresponding to the above €350). On the other hand, if the yields were €850 then the maximum instalment would be €298 and maximum funding would be 87.000€, meaning that would not be approved-

We suggest getting the right information prior to taking any formal commitments.

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