When we first started saving for our first place we had heard of the housing ladder but we really had no idea how it worked and we didn't really understand mortgages in general. To explain mortgages and the housing ladder, it's probably best to start with a basic overview of some terminology.
What is a deposit?
A deposit is a monetary amount you put down with the bank to secure a mortgage. It's like telling the bank "we have an investment in this deal". Deposits can be different percentages but the the more you put down, the cheaper the interest rate can be.
What is "Loan to Value" or LTV?
In the context of being a first time buyer, ‘loan to value’ or LTV is the percentage that results from the deposit amount put down and the mortgage you require (loan) versus the value of the property.
So a simple example is: if you are looking at a £100K property and you have a £10K deposit, the loan to value ratio would be 90%.
You will see this percentage amount on mortgage websites, the lower the percentage i.e. the larger your deposit, the easier you are able to access lower interest rates (because the risk is lower for the mortgage provider due to the smaller loan required) making your monthly payments more affordable.
This value is the holy grail of the housing ladder. Let's again look at an example, if a property is worth £100k and the amount left to pay is £60K then the equity amount here is £40K. Equity can change in two ways, firstly by making payments to pay off the mortgage and secondly by housing prices changing.
This is the antithesis of the housing ladder! Negative equity is where the value of your home is less than your loan amount. This generally happens when house prices decrease and you were already in a high loan to value scenario. For homeowners it is a scenario to be avoided because it would be very difficult for them to move and if a mortgage deal is coming to an end it can be more difficult to negotiate a reasonable interest rate leading to possible increases in monthly repayments.
So how does the housing ladder actually work then?
House prices tend to be on the increase (historically speaking). So when you have bought your property, two things typically happen:
1. You are paying down your mortgage each month, so the mortgage amount outstanding is decreasing.
2. Any house price increases are generally welcome because it means that your equity is increasing (nb. house prices general increase elsewhere so unless you are getting out of the housing market completely or moving to a place where increases are smaller or stalled this has limited benefits)
Equity is the difference between your house value and your outstanding debt.
Once you have a decent amount of equity, this allows you (if you desire it) to up-size because you can use the equity gained as a deposit in order to make monthly repayments affordable. With a big piece of equity, mortgage providers see you as a much safer bet since you own more of the risk.
We hope that this post sheds some light on how this all works! If you’re currently saving for a deposit on a house, or renovation work, then you might enjoy reading our popular post called “The 10 commandments to live by when saving for a house deposit.”
Hope this helps,
Fifi + Neil xoxo