A common one you’ll hear is the Loan-to-Value Ratio, or LVR, as it greatly influences the loan terms and interest rates you can achieve.This article will break down what LVR is, how it affects your borrowing power, and why it matters in the mortgage lending process.
What is Loan-to-Value Ratio (LVR)?
The Loan-to-Value Ratio (LVR) is a percentage of the amount borrowed through your home loan compared to the value of the property you want to buy. It is calculated using the following formula:
LVR = (Amount borrowed/Property value) x 100
For example, if you’re looking to borrow $400,000 to buy an apartment valued at $500,000, your LVR would be:
LVR = (400,000/500,000) x 100 = 80%
What do you need to know about LVR?
Risk assessment
LVR is used primarily by lenders to assess the risks of lending money to the borrower. The higher the LVR, the riskier the loan is for the lender as it means you’ve borrowed a larger proportion of the property’s value. These loans are generally deemed as more difficult to pay back, especially if your financial situation changes.
Loan approval
As part of their duty to mitigate risk, lenders tend to have a maximum LVR they are willing to accept. If your LVR is too high, you might need to provide a larger deposit, seek a guarantor to secure the loan, or risk being rejected for the loan.
Interest rates
Lenders often charge higher interest rates for loans with higher LVRs to compensate for the increased risk. Conversely, a lower LVR can help you secure a more favourable interest rate so use this knowledge to your advantage when providing a deposit.
Lenders Mortgage Insurance (LMI)
If your LVR is above a certain threshold (typically 80%), you may be required to pay Lenders Mortgage Insurance. LMI is insurance for the lender that protects them in case of default. It is not insurance for yourself as the borrower! It can be a significant cost for borrowers who may not have a choice if they don’t meet the minimum deposit required to lower their LVR.
What can you, as a borrower, do to lower your LVR?
It is no secret that a lower LVR can present favourable loan conditions to the borrower.
Save a larger deposit
Given a fixed property value, the more money you can save for a deposit, the lower your LVR will be. A larger deposit reduces the amount you need to borrow, which can help you save thousands in the upfront LMI cost and in interest rates throughout the life of the loan.
Select a property within your budget
Choosing a property that fits comfortably within your budget can help you maintain a manageable LVR. Overextending yourself on a more expensive property can increase your LVR and your financial stress.
In the end
Understanding the Loan-to-Value Ratio is key to making informed decisions when borrowing for a home. By managing your LVR, you can increase your chances of loan approval, secure better interest rates, and avoid additional costs like Lenders Mortgage Insurance.
Remember, with regular repayments and a steady increase in property value over time, the LVR may naturally decrease. In such cases, you might consider refinancing to benefit from better loan terms and lower interest rates.
Borrowers don’t need to be discouraged completely if they have a high LVR, as there could still be an appropriate lending product to suit them and their financial situation. Don’t hesitate to speak to one of our lending specialists to see how we can help.
Any advice provided is general in nature and should be considered in line with your financial situation, needs and objectives.
