Understanding Loan-to-Value Ratio in Property Finance

Understanding Loan-to-Value Ratio (LVR) in Property Finance

By: Nfinity Financials0 comments

This simple acronym is one of the most crucial things to know if you want to buy or Refinance a property. Why? You’ll gain an understanding of how much you can borrow, how to achieve the best interest rate, and the potential risks associated with borrowing. For only three little letters, there is a lot.

What is LVR?

The Loan-to-value ratio, or LVR, is the proportion of what you borrow divided by the property’s value. You might be able to borrow more money at cheaper rates and thus, lower repayments if your loan-to-value ratio is 80% or below. If your LVR is greater than 80%, you may need to pay LMI or have a family member act as a guarantor to reduce the risk.

How to calculate LVR?

There is an easy equation to figure out your loan-to-value ratio. It is the total of your loan, divided by the home’s appraised value, and then multiplied by 100 to get the percentage.

What isn’t included when calculating LVR?

Before you start calculating LVR, keep in mind that the loan amount does not include any upfront charges. It is best to take conveyance, stamp duty and other out of pocket expenses out of the calculation.

Now let’s look at how to calculate LVR in practical terms.

Let’s say, you sign a deal to buy a house for $500,000. In addition to all other expenses such as stamp duty, legal fees, and other costs, you have saved $100,000 for the deposit, thus you intend to borrow $400,000. Taking $400,000 divided by $500,000 and multiplying the result by 100 will result in an 80 percent loan toward the buying price.

This is how your equation would appear in a math class: LVR = ($400,000 loan ÷ $500,000 worth of property) x 100 = 80% 

Your loan-to-value ratio, or LVR, will be 80% if the lender accepts that the home’s value is equal to the purchase price. Your LVR will vary depending on whether you have more or less than $100,000 saved aside for the deposit. Your LVR will be 70% if you put down payment of $150,000. Your LVR will be 90% if you make a $50,000 deposit.

I’m ready to purchase. Is it important to borrow money above or below 80% LVR?

After discussing what LVR is, let’s get a little bit more into the details of it. You’ll discover that, in terms of LVR, 80% is a bit of a magic number.

Depending on whether your loan-to-value ratio is higher or lower, you will face different borrowing circumstances and dangers.

What should I know if I borrow up to 80% of the loan value?

You can obtain better rates by borrowing up to 80% LVR since the lender bears less risk. They are not lending you the entire (or almost full) worth of the home; instead, you are putting down 20% or more of the home’s value. Furthermore, a lower loan-to-value ratio gives the lender further confidence that in the unlikely event that something goes wrong, they will probably get their money back.

Additionally, if your loan-to-value ratio (LVR) is 80% or less, you won’t be required to pay the Lender’s Mortgage Insurance (LMI). At up to 80% LVR, the procedure is also typically a little bit simpler. A quick and easy desktop appraisal could serve as the lender’s valuation. A credit assessor may utilize a computer-based method to estimate the worth of a home rather than sending someone to visit the property in person, which can take some time. 

What should I know if I borrow more than 80% of my property’s value?

Many lenders will ask you to take LMI once the loan amount exceeds 80% of the property’s value. Due to the higher risk involved in your loan—the loan amount is closer to the valuation, giving the lender fewer options if something goes wrong—you may have to LMI, an insurance premium called Lenders Mortgage Insurance.

It takes the form of a one-off insurance that a lender may ask  you to take in order to protect itself from any losses incurred if you are unable to repay your home loan. It is an additional expense that is added to your overall loan balance, raising the total amount of your loan.

You’ll frequently see that interest rates increase above 80% LVR, indicating that the cost of repaying your loan would be higher. Additionally, if you’re planning to purchase at auction or pre-auction with an anticipated higher-than-80% LVR, be cautious of the risks related to lender valuations that could impact your capacity to actually borrow money.

If the lender determines that the home is worth less than the purchase price, you may find yourself in a difficult situation because there is no cooling-off period. The reason we are saying that you may have to take LMI if LVR > 80% because in certain cases this may get waived, like,

  1. Govt scheme – Home Guarantee Schemes
  2. Certain lenders have LMI waiver policies
  3. Certain lenders can waive off LMI depending upon your profession / qualifications

What happens if the valuation comes back less than I expected?

If you plan to borrow up to 80 percent LVR, you’ll have a cushion in case the valuation is erroneous. In the event that the lender declines your offer, which could happen if the home’s worth has decreased since you purchased it, you could still be able to borrow additional funds to cover the shortfall.

In the previous situation with a $500,000 purchase price, if the home’s appraiser for the lender determines it’s only worth $450,000, they will probably only grant you $360,000 at 80% LVR. This implies that in order to make up the difference, you’ll need to increase your deposit to $140,000 (instead of $100,000). Alternatively, you can think about taking a loan at 85% or higher LVR.

Let’s say you decide on 85% LVR, the lender will lend you $382,500, which will get you closer to your initial deposit amount. Naturally, the lender will consider other serviceability considerations, so you should confirm this with them.

When the loan-to-value ratio (LVR) exceeds 80%, LMI may apply and the interest rate may increase. However, at least you will know that you can make a payment and won’t risk losing your deposit.

Is there any benefit to paying LMI?

In some cases, paying LMI can be beneficial. When considering the big picture, the cost of Lender’s Mortgage Insurance becomes more bearable if you have to put off purchasing your first home for a number of years in order to save the difference. LMI might be a fraction of cost compared to how much house prices may have risen in that time.

How can my LVR be lowered?

There are alternative methods for reducing your LVR. One option is to designate a parent or other close relative as a “Guarantor” for your loan. To secure your repayments, your guarantor utilizes the equity in their own house.

A promise made by the guarantor that you, the borrower, will adhere to all loan terms and conditions is known as a guarantee. This suggests that in the event that something were to happen to you that would make it impossible for you to follow the terms and conditions of the loan, i.e., make you unable to pay your mortgage, the guarantor would agree to pay the lender all money owed under a loan (including with any reasonable enforcement charges) as soon as the money is requested.  If you apply for a home loan with a guarantor, LMI might not be required. The guarantor must understand the terms before signing this.

Examining several approaches to raising your deposit is another strategy to lower your LVR. This is the point at which preparation is your greatest ally. It’s best to start saving for your deposit as soon as possible. If you plan to purchase a home in the near future, figure out how much you can afford to spend and what your preferred loan-to-value ratio is. Then, begin setting money aside for this purpose.

Ready to buy?

If you’re ready to make a property purchase but aren’t sure which house loan is best for you, read Our Articles or schedule a discovery call At 1300 GET LOAN.

Related post

Leave A Comment