Loan-to-Value Ratio (LVR): What You Must Know
When looking at your first home loan, one term that you probably have heard of is LVR or 'loan-to-value ratio'.
LVR is simply the amount of money you need to borrow as a percentage of the purchase property's value. Therefore, the larger your deposit, the lower your LVR will be.
As we are in a rising interest rate cycle of the property market, the goal is to work out how to minimise your LVR to help you over the long term.
Here’s how you can do that and understand your alternatives, whether this is your first home or consecutive loan.
LVR and your home loan
Banks and home lenders use LVR to assess your loan's risk. Generally speaking, when your LVR is> 80%, most lenders consider this loan riskier than those < 80%. Naturally, the lower your LVR, the less you will need to repay in the long term.
One significant advantage of an LVR < 80% is you avoid paying extra fees, such as Lender's Mortgage Insurance (LMI).
However, if you need to borrow with an LVR > 80% and have a smaller deposit, you will find that most banks can assist you.
LVR applies to other loan types, including investment, commercial property and when you refinanced from another lender.
Calculating your LVR
To calculate your LVR, divide the amount you plan on borrowing by your bank's valuation, then multiply this figure by 100.
For example, if you're buying a property in Strathpine QLD valued at $550,000, you have a $80,000 deposit. So in this scenario, you need to borrow $470,000.
You divide the $470,000 by $550,000, which is 0.84, multiply by 100, and your LVR is 84%.
As this LVR is > 80%, you may decide to wait to purchase this property and save a larger deposit.
Understanding how to calculate your LVR is extremely useful in working out how to avoid paying LMI. When you know the value of the property you're interested in purchasing, you can work out what deposit you need to avoid LMI.
What's the difference between the bank and market valuation?
A bank valuation is an independent valuation to determine the property's value. Generally, a bank valuation is considered a risk assessment. It's an estimate of what the bank can reasonably expect to recover if you fail to repay the loan and the property needs to be sold.
Often, the bank valuation is lower than the market appraisal.
The market valuation is a real estate agent's estimation of the house's worth in today's property market. Realistically, it considers the present conditions and does not look at how the property value will change in the future.
Your bank and lender will often calculate your LVR on the lower figure.
For example, if the bank values the property in Strathpine at $525,000 (as opposed to the $550,000 listed price), the bank calculates your LVR on the lower figure. Therefore, with your $80,000 deposit, you will still need to borrow $470,000, so your LVR is 89% (applying the calculation outlined above using the bank’s valuation).
What happens if your LVR > 80%
You don't need to be concerned if your LVR is> 80%, as most lenders will accept your application.
However, you should be aware most lenders will not exceed a 95% LVR.
When your LVR is above 80%, your application is more closely reviewed, including your loan repayment ability. Sometimes, you are offered a higher interest rate to offset an additional risk.
Regardless of your loan's interest rate, it's highly likely that your application with an LVR > 80% will incur LMI.
Lender's Mortgage Insurance (LMI): Explained
LMI is a fee to protect your bank from the additional risk they agree to take with your loan when your LVR exceeds 80%.
Usually, it's a one-off fee you pay at the loan's establishment and is added to the loan amount you borrow.
It's worthwhile considering LMI to get into your property sooner without saving a larger deposit.
You should also be aware that LMI protects the lender. However, it won't protect you or a guarantor if you fail to repay your home loan.
Other LVR considerations you should know
How to reduce your LVR
The quickest way to reduce your LVR is to increase your deposit, which we understand can be challenging with the cost-of-living crisis. But if you have an idea of your price range for your property, then working out your likely LVR can be helpful to set a savings goal.
Alternatively, some lenders may allow you to sign a guarantor to your loan (typically a family member). A guarantor must be willing to use their home's equity to safeguard your repayments. LMI is not applicable with a guarantor, as their equity is acting to cover your deposit when LVR > 80%.
However, you will risk your family member's home if you fail to repay.
What is considered a good LVR?
Any LVR < 80% can be considered 'good'. A lower LVR means you avoid paying LMI and need to borrow less, leading to lower interest charges paid to your bank over the loan term.
Can LMI help?
If you are still trying to save a 20% deposit to get your first home, choosing LMI can help you quickly reach the property ladder. In many
cases, it shaves years off, saving a larger deposit.
I've heard of 100% LVR - is this an option?
Yes, in some circumstances, you can borrow 100% LVR if you have no deposit, but this is generally only available to loans guaranteed by a family member, as mentioned earlier.
Need help working out your deposit?
At Ramsey Property Wealth, we employ strategies to help you shrink debt and guide you towards paying off your home loan faster i.e reducing your LVR on your property. If you’d like to know how much you can borrow, speak to a Ramsey specialist Mortgage Consultant Advisor who can review your financial situation and prepare a pre-approval based on your maximum borrowing power.needs and goals.
Book your appointment or call 1300 001 215.