Do you have a mortgage? Do you know what your loan-to-value ratio is – and what interest rate band that puts you into with your bank?

Oh, I see… You have other hobbies.

Look, I appreciate there’s nothing more boring than a mortgage deal. Especially when half of you already know what I’m talking about, and will nod off in about 150 words’ time.

But if you don’t, please keep reading. You might save yourself a lot of money.

Just ask Richard, a first-time buyer.

Richard was stretching to buy his first flat. And because I’m the sort of person who has blogged about money for 17 years, I asked him what his loan-to-value was.

“Huh?” said he.

Long story short: by releasing an extra £2,000 from an ISA he’d mentally segregated for something else, Richard could reduce his total mortgage repayments over the next five years by over £8,000.

That’s a 300% return on the extra £2,000 he put down!

What is the loan-to-value ratio for a mortgage?

I’ll say upfront: this is a particularly extreme example. Richard is arty, clueless with money, and rarely reads a menu let alone the financial small print.

What’s more Richard was set to borrow at his bank’s steepest rate for first-time buyers, before he found that extra money down the back of the metaphorical sofa. The savings will rarely be so big.

Nevertheless the principle holds for all mortgages.

And personally I’d rather have any extra money, however tiny, if the alternative is it goes to a bank.

So what’s going on here?

Well, it starts with the loan-to-value (LTV) ratio of your mortgage.

The LTV ratio is simply the ratio of what you’re borrowing from the bank – the mortgage – compared to the purchase price of the property.

For instance, say you’re buying a home that costs £400,000 and you’ve got a £100,000 deposit. You’ll need a £300,000 mortgage to complete the purchase.

• That is a LTV ratio of £300,000/£400,000, which works out at 75%.

Or say you have a mortgage of £270,000 on a £336,000 property.

• The LTV ratio is £270,000/£336,000 = 80.35%

As we’ll see in a moment, those pedantic two decimal places are the whole point of this article.

But first a quick detour into why banks care about LTV ratios.

Loan-to-value ratio and riskiness

Although it remains hard for those of us who lived through the financial crisis to believe it, banks are in the business of managing risk and return.

And mortgages are the least risky debt – for both banks and borrowers.

That’s because mortgages are secured loans.

The property being bought is put up as collateral by the borrower. If you don’t meet your mortgage payments, then your bank can seize and sell your property to cover the mortgage and recoup what it lent you.

This clearly makes a mortgage a safer form of debt for the bank, because it is asset-backed.

But it’s also safer for you as a borrower. The rate charged on an asset-backed mortgage will be much lower than that on a credit card or a personal loan.

Less risky does not mean risk-free. A mortgage is still a big liability, and you can lose a lot of money if things go against you. All debt has downsides.

Of course, banks aren’t desperate to seize and sell their customers’ assets to get their money back. Partly because it makes for bad publicity, particularly when they’re all at it. But also it’s costly and time-consuming.

And most importantly – bad news tends to cluster.

The very time when a bank’s borrowers are defaulting en masse on their mortgages will invariably be a terrible time for the economy more widely – and probably for house prices, too.

Banks could be seizing and selling properties into a falling market (as they did in the early 1990s).

Which means that in a steep house price crash, the bank could fail to recoup the money it had lent out against the mortgage when it sells. Especially once all the various costs are factored in.

And again, despite how it looked in 2008, banks don’t really want to be losing money on one of their main lines of business.

The loan-to-value ratio and interest rates

Obviously this unhappy loss-making outcome is more likely when the mortgage made up most of the money used to buy the property.

In other words – when the purchase was at a very high loan-to-value ratio.

In that case, the equity in the property – the difference between the house price and the mortgage – is very small. There’s not much safetly buffer, from the bank’s perspective. So little in fact that after a house price crash it could be wiped out and even go negative. (Hence the term ‘negative equity’.)

To reflect this risk of losing money on small deposit house purchases, banks charge greater interest rates on their higher LTV mortgages.

At the very highest LTV levels – where the borrower puts down just a 5% deposit or maybe nothing at all – rates will be far higher than for borrowers with a chunkier deposit who borrow from the same bank.

Banks typically obfuscate all this with their mortgage filters and other tools. But a few do make it admirably plain via downloadable lists of all their products.

Here’s an example of what we’re talking about:

Source: Virgin Money

Here the mortgage rate falls by 0.24% for buyers who put down an extra 20% deposit, meaning their LTV ratio is 65% compared to 85%.

On a £300,000 mortgage, that’d be a difference of £42 a month, or £2,520 over five years. Not enormous, but certainly worth having.

But the LTV bands in this example are very wide. You’ll find them stepping down in 5% increments with some lenders.

In my initial example, for instance, Richard was originally borrowing on a LTV ratio of 95%. His bank was looking to charge him 5.75% over five years.

By putting in a little more cash, Richard dropped to an LTV ratio of 90%. The interest rate in that band was a far cheaper 5.04%. Which was what made for the vast savings we saw over five years.

Mind the cliff edge

You might say this isn’t rocket science – and I agree, it’s not – and that if you had an extra 20% of the purchase price to casually reduce the size of your mortgage, you’d do it already.

Fair enough – but that’s not what I’m talking about.

The point is these LTV bands are arbitrary and typically pretty rigid.

Again, Richard he didn’t have to put down an extra 5% deposit to drop into the much cheaper mortgage bracket.

His deposit was already big enough such that his LTV ratio was only slightly above 90%. Putting in just £2,000 to get the LTV ratio below 90% is what unlocked a cheaper rate and saved a fortune.

The return on those marginal pounds was enormous, as I showed above.

Now, many of the sort of people who read Monevator will find this obvious. Which reminds me of my former housemate, Nat, who I used to compete with while watching Who Wants To Be A Millionaire?

Nat was never very self-aware about this – even when I pointed it out to her – but there were only two categories of questions in this quiz as far as she was concerned.

“Too easy, everyone knows that!” (when she knew the answer) or “Impossible, that is so obscure!” (when she didn’t).

Similarly, all this may be obvious to some, but others aren’t used to thinking about money this way.

In my experience people often have, say, a pot of cash for the house deposit, and another pot set aside for furnishing the property or for buying a car or simply labeled as nebulous ‘savings’.

Depending on how close to the LTV ‘cliff edge’ they are, it could make much more sense to add that money to the deposit, unlock a cheaper mortgage, and to then use say a 0% credit card to furnish the new home. (Provided they can trust themselves to pay it off, of course!)

Alternatively, they might employ removal boxes as furniture like I did when I bought, and gradually furnish their new home out of the cashflow freed up by the resultant cheaper mortgage!

A few final pointers about loan-to-value ratios

With so much financial business done online nowadays, I suspect a lot of people simply click through a mortgage comparison site with little idea about the loan-to-value ratios driving the rates their offered – let alone how much they might save by putting down a little bit more as a deposit.

So a few concluding thoughts about tweaking mortgage bands via the LTV ratio:

• Can’t increase your deposit? Maybe you can get into a lower band by driving a slightly harder bargain when you buy your home. Remember it’s the ratio that matters.

• Your loan-to-value ratio will have changed by the time you remortgage. A repayment mortgage reduces the size of the mortgage balance over time. If house prices rise your loan-to-value will fall further.

• Also look out for any opportunity to nudge yourself into a more favourable band when you remortgage by making over-payments.

While we’re on the subject, these sort of cliff edges pop-up elsewhere in personal finance. So stay alert.

You’re looking for marginal edge cases, where a small additional amount of money or some other tweak to your financial posture generates outsized returns.

For instance, increasing your pension contributions can enable you to retain your child benefit if it reduces your income below the critical threshold – a win-win.

Paid to play

It’s pretty dopey these arbitrary bands with critical thresholds still exist for mortgages. Not to mention other areas like stamp duty – and arguably even income tax.

Simple bands made sense when everything was worked out with a slide rule. But what’s the justification now? It’s all done by computer.

Ideally each of us would be offered a bespoke mortgage rate. This would reflect every facet of our unique financial situation. Such individualized underwriting would be fairer on borrowers – and perhaps safer for the banks as well.

Maybe lenders worry that bespoke deals – or even just narrower loan-to-value bands, with say 1% increments – could confuse us? Or even lay them open to mis-selling claims?

Whatever the reason, for now it pays to pay attention to the small print.

Got a favourite example where some marginal additional pounds unlock outsized benefits? Please share all in the comments below!

This past year has not been pretty for investors. Indeed it’s the worst on record for our Slow and Steady passive portfolio – even after a slight bounce back from last quarter.

We’ve taken a -13% loss during benighted 2022. Our previous all-time bruising was a mere -3% knuckle-scrape from 2018.

In fact we’ve only had three down years since the portfolio began in 2011. Six years ended with double-digit gains!

So while most of us understand that all good runs come to an end, I do worry we could still be mentally unprepared for a sustained spell of negativity.

Mental as anything

How many of us got used to glancing at our portfolio for a quick ego boost during the good times?

Gains dancing before our eyes and seemingly rearranging themselves into the words: “You’re doing brilliantly, old chum. Keep it up!”

How will we now fare when incessantly poor numbers decrypt into the sub-text: “You’re going nowhere, ya loser!”

We know all the powerful mantras to recite to ward off devilry:

• “Investing is a long-term game.”
• “Buy low, sell high.”
• Be greedy when others are fearful.”

And anyone who’s read their financial history appreciates a key test is keeping your head when the markets play rough.

But can we keep the faith?

Down but never out

While we sit on our hands and wait for the good times to return, here’s the latest numbers from the Slow and Steady portfolio in 8K Drama-O-Vision:

The Slow & Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000. An extra £1,200 is invested every quarter into a diversified set of index funds, tilted towards equities. You can read the origin story and find all the previous passive portfolio posts tucked away in the Monevator vaults.

The investing Razzie for 2022 has to go to UK government bonds. Our gilt fund lost 38% after inflation1, comfortably surpassing the previous historic low of -33% in 1916.2

We’re truly on the horns of a dilemma with bonds.

If inflation isn’t suppressed and bond yields climb vertically then even worse could follow. UK gilts suffered real-terms losses of -68.5% from 1915 to 1920.

But before you reach for the ‘bond eject’ button, know that gilt disaster was followed by a spectacular 480% rebound from 1921 to 1934.

Sack off bonds after a bad year and you can miss some big rallies:

• 1920: -19.7%
• 1921: 27.4%

• 1974: -27.2%
• 1975: 10.9%

• 1981: -1.6%
• 1982: 42%

• 1994: -12.2%
• 1995: 14.5%

• 2013: -8.5%
• 2014: 13.9%

Inflation-adjusted real returns. Data for UK gilt nominal returns from the JST Macrohistory database.3

Bonds spook many investors because they’re esoteric. But the fact is – like equities – bonds have bouncebackability.4

Dump your bonds now for cash and you may crystallise a loss that currently only exists on paper…

…or you may save yourself more pain, if it turns out we’re in for a rerun of the 1970s.

Given the uncertainty, I wouldn’t blame you for reducing bond exposure. But I respectfully suggest you avoid ‘all or nothing’ reactions such as swearing off bonds for life.

The long view

After a year like 2022, it’s probably better to count our blessings over a longer timeframe.

Stepping back we can see the portfolio has made a nominal annualised return of:

• 1.6% over 3 years. (Miserable!)
• 3.3% over 5 years. (Pants!)
• 6.3% over 12 years. (Actually, I’ll take it!)

That’s around 3.3% annualised in real returns. Historically we might expect an average 4% annualised from a 60/40 portfolio.

So while we’re currently sub-average, it’ll have to do for now.

One year ago that same number was a rollicking 9.8%. Things can change quickly.

Building back better?

Our property fund’s -25% real-terms annual loss was peak awful on the equity side of the Passive Portfolio’s scorecard.

Curse you rising interest rates!

And how do corporates deal with bad news? They rebrand it.

Coincidentally, iShares decided it was high time our dilapidated old global property tracker got a new lick of green, eco-conscious paint.

On 24 November, the fund changed its name from this:

iShares Global Property Securities Equity Index Fund

To this:

iShares Environment & Low Carbon Tilt Real Estate Index Fund

Despite some confusion on iShares’ website, it’s also changing the fund’s index from this:

 FTSE EPRA/NAREIT Developed Index

To this:

FTSE EPRA/NAREIT Developed Green Low Carbon Target Index 

The gist is that the vanilla property tracker now has an Environmental, Social, and Governance (ESG) twist.

The new index apparently screens out companies that deal in weaponry, tobacco, and fossil fuels.

It also excludes – or at least takes a dim view of – anyone into human rights abuses, child labour, slavery, organised crime… that sort of thing.

Finally, it up-weights those constituents whose property holdings are deemed sustainable. That means they have to make an effort to be energy efficient and to obtain ‘green building certification’.

It all sounds excellent in principle – I doubt many of us want to prop up the share prices of slum landlords running slave gangs.

But just how radical a change is this in practice?

I must admit I’m not over familiar with the micro-details of the FTSE EPRA/NAREIT Developed Index.

Still, I’ve found one commentary about the switch from a firm of financial advisors called Old Mill, which says:

An initial look at the proposals suggest there will be little change in the underlying investments of the fund, with 23 of the approximately 340 investable companies being excluded.

And my own eyeballing of the respective index factsheets reveals:

• A reshuffle of the Top 10 holdings into slightly different percentage weights.
• Rejigged sub-sectors.
• Industrial, retail, and healthcare REITs are down 1-2% in the green index.
• Office and residential REITS are up 1-2%.

Call me Graham Thunberg but this doesn’t smack of saving the planet.

Meanwhile, the five year annualised returns (the longest available) published for the two indices reveal:

• 0.5% a year for the green index
• 1.5% a year for the standard index

While I admire people who want to invest in line with their values (assuming they’re not massive fans of cluster bombs and extortion) I’m personally dubious about the ESG label.

The potential for greenwashing is enormous. And I despair about my chances of verifying the ethical claims given:

1. The finance industry is adept at misdirection
2. We’ve been gaslighted about climate change for more than 30 years

There’s also a danger of individuals ticking the ESG boxes and then forgetting to take direct action like:

• Cutting back on planes and meat
• Trading in a gas-guzzler for an electric car
• Turning down the thermostat
• Voting for the political party with the best green policies

Still, as a card-carrying passive investor I’m inclined to keep our holding as is.

What say thee?

The one reason I’d consider switching to a new property fund is because the Slow and Steady portfolio is meant to be demonstrative for our readers.

Hence our property allocation is supposed to test the benefit – or otherwise – of diversifying into global real estate.

All this ESG gilding muddies the picture. I’d rather create an ESG version of the portfolio to illustrate the trials and tribulations of socially responsible investing.

That’s my opinion – but I’d really like to know what you think.

Should passive fund managers switch their index trackers to green indices?

Should I swap this fund for one focused purely on commercial property as an asset class?

Would you like us to come up with an ESG passive portfolio? That way we can contrast the fortunes of saint and sinner stocks alike.

Please let me know in the comments below.

Annual rebalancing time

I’ll run quickly through the annual portfolio maintenance because this post is already loooong.

We previously committed to an asset allocation shift of 2% per year from conventional gilts to index-linked bonds until we have a 50-50 split between them.

That means:

• The Vanguard UK Government Bond index fund decreases to a 27% target allocation
• The Royal London Short Duration Global Index Linked (GBP hedged) fund increases to a 13% target allocation

Our overall allocation to equities and bonds remains static at 60/40.

We also annually rebalance our positions back to their preset asset allocations at this point in the year. After 2022 that means selling off a portion of our badly performing equities and buying into battered bonds.

It’s a counterintuitive move (as discussed above). But over the long-term rising bond yields mean gilts are now better value than they were.

Inflation adjustments

To maintain our purchasing power, we must also increase our regular investment contributions every year by inflation.

We use the RPI rate. It has ballooned 14% this year according to the Office for National Statistics. (CPI was 10.7%).

So we’ll invest £1,200 per quarter in 2023. That’s up from £1,055 in 2022 and a titchy £750 back when we started in 2011.

New transactions

Our £1,200 contribution is split between our seven funds according to our predetermined asset allocation. The trades play out like this:

UK equity

Vanguard FTSE UK All-Share Index Trust – OCF 0.06%

Fund identifier: GB00B3X7QG63

Rebalancing sale: £457.14

Sell 1.951 units @ £234.35

Target allocation: 5%

Developed world ex-UK equities

Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.14%

Fund identifier: GB00B59G4Q73

Rebalancing sale: £984.72

Sell 1.958 units @ £502.91

Target allocation: 37%

Global small cap equities

Vanguard Global Small-Cap Index Fund – OCF 0.29%

Fund identifier: IE00B3X1NT05

Rebalancing sale: £124.68

Sell 0.334 units @ £372.79

Target allocation: 5%

Emerging market equities

iShares Emerging Markets Equity Index Fund D – OCF 0.2%

Fund identifier: GB00B84DY642

Rebalancing sale: £280.10

Sell 156.435 units @ £1.79

Target allocation: 8%

Global property

iShares Environment & Low Carbon Tilt Real Estate Index Fund – OCF 0.17%

Fund identifier: GB00B5BFJG71

New purchase: £134.76

Buy 60.596 units @ £2.22

Target allocation: 5%

UK gilts

Vanguard UK Government Bond Index – OCF 0.12%

Fund identifier: IE00B1S75374

New purchase: £1957.69

Buy 14.781 units @ £132.45

Target allocation: 27%

Global inflation-linked bonds

Royal London Short Duration Global Index-Linked Fund – OCF 0.27%

Fund identifier: GB00BD050F05

New purchase: £954.18

Buy 921.911 units @ £1.04

Dividends reinvested: £203.38 (Buy another 196.502 units)

Target allocation: 13%

New investment contribution = £1,200

Trading cost = £0

Take a look at our broker comparison table for your best investment account options. InvestEngine is currently cheapest if you’re happy to invest only in ETFs. Or learn more about choosing the cheapest stocks and shares ISA for your circumstances.

Average portfolio OCF = 0.16%

If it all seems too complicated check out our best multi-asset fund picks. These include all-in-one diversified portfolios such as the Vanguard LifeStrategy funds.

Interested in tracking your own portfolio or using the Slow & Steady investment tracking spreadsheet? Our piece on portfolio tracking shows you how.

Finally, find out why we think most people are better off choosing passive vs active investing.

Take it steady,

The Accumulator

1. -27% in nominal terms with CPI inflation at 10.7%. [↩]
2. See the JST Macrohistory database, which documents UK gilt returns since 1871. [↩]
3. Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2019. “The Rate of Return on Everything, 1870–2015.” Quarterly Journal of Economics, 134(3), 1225-1298. [↩]
4. The riskier, longer maturities do anyway. Short-term bonds more closely resemble cash. [↩]

What caught my eye this week.

I love this time of year. No, of course not the short, dark, dreary days. I spent a lot of my childhood in sunnier climes and the Seasonally Affected Depression is real.

But rather the sense of nothing pressing to do.

Granted this is a privilege, albeit the result of my choices.

I deliberately don’t have kids dragging me all over the place. I’ve literally made it my business not to have a stressful work life. I’m very grateful for my wider family life, but once Christmas is over it’s a week of limbo and I relish it.

There are pros and cons to this rather ascetic way of living, certainly. I can see for some it might appear a bit barren.

But it suits my unusual temperament, and importantly it isn’t hurting anyone.

Winter wonderland

That said, I have developed some seasonal routines.

For example I tend to do a bit of midwinter purging of junk and clutter. And while I don’t commit to strict New Year resolutions, I do try to think a little more about what I might do better next year.

Currently I’m minded to eat meat only twice a week, work harder to see farther-flung friends, and hunt for more ultra long-term holds for my portfolio.

We’ll see.

On the purging of junk front, I also love resetting my massive investing spreadsheet.

My sheet starts with ‘my number’ at the top of the top sheet. That’s driven by various sub-sheets that calculate the shifting value of my portfolio in real-time. These also remind me where all the skeletons are hidden what is on which platform, and throws out interesting statistics about my shifting exposures and returns.

Zeroing it all ready for a new year is for me a special kind of slightly Rain man-y pleasure.

I see some of you are scoffing at the back?

Yes of course a year is an arbitrary orbit of the sun. Indeed, neither the world nor the markets are magically transformed on 1 January. (Although in retrospect 2022 sure looks that way.) I agree it’s all mental accounting and biases.

But hey, I’m a (mental) human and I am biased. And I can’t wait to delete the negative numbers and reset the counters.

Beans, beans, they’re good for your heart

Many years ago I met the best-selling author Robbie Burns of Naked Trader fame. We talked about investing.

Robbie was dismayed about my Buffett-y habit of averaging down on my losers:

“Why would you want to stare at your failed trades all day? It’s depressing. I get rid of them.”

I thought Burns’ advice was ridiculous at the time. But now I think it’s more wise than not.

Sometimes you have to learn a lot of complexity to realize some simple truths.

In 2023 I’ll feel happier about my active investing – and I suspect I’ll do better accordingly – because I (hopefully) won’t have to keep seeing (and reacting to) how I’m lagging the market year-to-date over an arbitrary time period in a portfolio that can’t sensibly be said to be winning or losing over anything less than at least five years, at least not without luck looming large.

Agreed: this is intensely stupid. But it’s hard won self-awareness too.

I’ll be working on that flaw in 2023, as I cook my beans instead of a pork chop and try yet again to tie down some much busier friend for a weekend away.

Maybe you’re a sensible passive investor and you already have more time to devote to the most important things in your life?

Regardless: what will you be doing more or less of, investing or otherwise?

Let us know in the comments below. And happy new year!

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