The best mortgage rates are saved for those who have more equity in their property. Equity is the amount of the property you own, which is the difference between what you could sell for (the ‘market value’) and what you owe on the mortgage. The remaining property value is owed to the bank via your mortgage.
The proportion of the mortgage vs the market value is also called Loan to Value or LTV. An LTV of 80% means you still owe 80% of the house value to the bank or conversely, you own 20% equity in your property.
For example, if your house is worth £250,000 and your mortgage is £200,000, then 80% of the value is owed to the mortgage loan. This would be 80% LTV. The remaining £50,000, which is 20% of the £200,000 market value, is your equity. If you sold today for £200,000 and paid the bank back £200,000, you would be left with £50,000.
A lower percentage LTV means that if you stopped paying the mortgage and the bank had to sell your house, they have less to recoup, which lowers their risk. As a reward, you pay a lower interest charge each month.
Those starting out on the property ladder with a higher LTV are also subject to the highest interest rates as they are perceived as a higher risk. This means you are paying more in interest every month and less off the balance of your mortgage.
There is however a tipping point where mortgage interest rates start getting cheaper. The table below compares the interest you would be paying on a £200k mortgage each year with different LTVs:
As you can see, the amount of interest you pay each year drops significantly as your LTV reduces. While this is just a snapshot in time of the mortgage rates available, it shows the significant difference lowering your LTV has. The difference between the top rate and the bottom is over £5,000 per year!
By lowering your LTV you also open up the mortgage market to more lenders and better rates. Banks scramble to offer great deals on what they would consider lower-risk loans. This becomes a beauty parade as mortgage lenders one up to appeal to those with a lower LTV!
However, as you can see, once you get below 75-80% LTV, then the savings on offer actually start to reduce.
In summary then, if you have a high LTV above 80%, then perhaps overpaying the mortgage to reduce this is the next place to start. However, if you are at or below this point, then perhaps you should consider which will give you better returns: overpaying your mortgage or start/increase investing.