A question I am sometimes asked is, ‘Peter, what is the ideal amount of loan to value to have spread across a portfolio, or even on individual properties, and how would you know what that figure is?’.
Well, it’s an interesting question, and I have to say that in my opinion there are no hard and fast rules on this.
A lot of this is going to depend upon what it is you are trying to achieve. It’s also going to depend upon your current circumstances, and it might even depend on something like your age. Let me explain what I mean by that.
First of all, let’s think about what loan to value means. Loan to value is essentially the amount that a bank are going to lend you against the value, or the purchase price, of the property. Remember, a bank will always lend on THE LOWER OF either the price or the value.
It’s possible that as you hold properties and you build your portfolio in future years, the loan to value of any existing loans will change when calculated against the property value.
So, you’d have the choice of leaving the mortgage as is, and seeing the LTV fall in time.
Or you could refinance as values increase and maintain the LTV at its original level.
A typical buy to let lender will lend you 75% loan to value although there are some lenders who will lend 80%, or even 85%, loan to value.
Having said that, if it’s a more expensive property, they’ll pair back the amount they’ll lend because of The Stress Test (something I’ve covered in a previous newsletter – here’s a link to my blog article https://www.thepropertyteacher.co.uk/the-rules-and-regs-on-stress-testing-mortgages-and-rent-cover-requirements/), so for a more expensive property you may find you can only borrow 65% or even 60% LTV.
When I first started buying property I was very aggressive. I was trying to get the maximum amount of money out of my portfolio all the time. Why? Because I wanted to build a big portfolio which was going to give me decent cash flow.
One of the ironies is that the more you borrow, the more it impedes your cash flow because you are paying more mortgage interest because you are borrowing more money.
But on the other side of the equation, the more money you take out, the more money you’ve got which you can use for deposits on other purchases, and so you’ve got to balance the figures, do your maths, see how it works out.
I came to the conclusion it was better to get the money out, as much money out of the portfolio as I could, so that I could buy more and more properties. Because I was being very aggressive about it, whenever I could, I was using an 85% loan to value product, and that worked well for me.
The argument against being that aggressive is, what if something happens like there’s another credit crunch, what if the property market crashes, what if values fall? Well, we know that it’s not an “if” the property market falls, it’s definitely going to happen some day, but I don’t know when, you don’t know when, nobody actually knows when it will happen.
But, in my experience, and history tends to repeat although we can’t always assume that history will repeat in exactly the same way, property values tend not to fall as much as people always assume they will when they’re worrying about this kind of thing.
Even in 2007, I think if you look at the overall average figures for the UK property market, in many areas prices didn’t fall 20% (although in a few areas it was slightly more than that).
And one thing we can learn from history is that whenever there’s a crash, there’s always a recovery (so far!).
Why is that? Because the fundamentals which drive the property market don’t change even when there’s a crash. And, also, the Bank of England are charged with creating an inflationary economy. All of these things work in our favour. So, if you go through and you look at the different house price indices going right back to the beginning, you’ll see that there are peaks and there are troughs, there’s points where the market is booming and there’s points where the market is crashing, but the overall trend is up.
And it’s up because of the inflationary pressures on the property market.
Even if the property market crashes, we can assume that at some point it is going to recover, so the big question is, can you sustain yourself (i.e maintain your investment) while you’re waiting for the market to come back?
If you can, if the cash flow is sufficient to keep paying the mortgage interest on your properties, then the loan to value amount is almost irrelevant. It only becomes an issue if you have to sell the property. If the property market has crashed by 25% and you took out an 85% loan to value product then, clearly, you’re going to sell at a deficit, that is going to hurt. But that is only going to be a problem, though, if you have to sell. If you don’t sell, it’s not a problem.
The key thing is to think about your circumstances, and to look at where we are in the economic cycle.
You might be reading this 5 years after I write it, or 10 years after I write it, the internet is an amazing thing, I’m here forever! So think about what’s happening in the market now.
And think about what your aspirations and your goals are.
If you’re younger, you may take a more robust view because you may think, ‘I’m only 30 and I’m going to be in property until I’m at least 70 or 80, so I’ve got another 50 years to ride this out. Even if there’s a crash in 10 years I’d still have another 40 years to watch the recovery’.
But if you’re currently in your 60s or 70s, and you’re trying to build a nest egg for your retirement, then maybe you want to take a more cautious view, and you may be thinking ‘I’ll use a lower loan to value mortgage product’.
So, is there a right or wrong answer as to which LTV you use?
In my opinion, no.
I hear learned people saying that a good point to get to, is to have a 60% loan to value across your whole portfolio.
No doubt that’s a worthy goal, so that’s fine. If you’re older you may say that’s the point I’m aiming for. But if you are young and more ambitious you may want to say, actually, I want to be more aggressive than that in the immediate future, but I’ll plan to end up with a lower LTV across the portfolio when I’m older.
It’s very personal and what is right or wrong for you will come down to who you are and what you want to achieve.
Peter Jones B.Sc FRICS
By the way, I’ve rewritten and updated my best selling eBook, The Successful Property Investor’s Strategy Workshop, which is an account of how I put together my multi-property portfolio, starting from scratch and with no money of my own, and how you can do the same. For more details please go to ThePropertyTeacher.co.uk