The little-known money-saving trend refinancers need to know

Refinancing a home loan can feel increasingly like a gambit. You’ll need to avoid the home loan hostage trap, compare mortgages until you find the deal, and face some incredibly steep serviceability tests. 

But since one of the main reasons to refinance is to save money, is there a secret money-saving hack you need to know to refinance? 

Indeed there is – and it’s called your loan-to-value ratio. So what is your LVR, and how can it help you save money when refinancing a home loan?

Your loan-to-value ratio, or LVR, is how much you’ve borrowed in a home loan divided by the total value of your property. You can think of it like this equation:

• LVR = loan value/home value

LVRs are usually expressed as a percentage. For example, lenders may say a specific mortgage offer requires an LVR less than or equal to 80%. 

When you first take out a home loan, your LVR is established by the size of your home deposit – usually at least 20% of the property’s value. Your home deposit is a security downpayment that helps you own part of your property from the start. 

If you pay a 20% deposit, then your LVR is 80% because you’ve already covered the first 20% of your property’s value, while the loan pays the rest when you buy it.

A smaller deposit (10%) would give you a higher LVR (90%), while a bigger deposit (40%) would give you a lower LVR (60%), and so forth.

Because your LVR establishes how much of your property you own, it partially determines your degree of financial risk to the lender. Risky borrowers usually cop higher interest rates and fees, while safer borrowers get rewarded with lower ones. So if you’re calculating the true cost of a home loan, your LVR is essential to know because it determines which interest rates you’re eligible for. 

Your LVR usually lowers with time as you pay off your home loan. The more you pay off, the lower your LVR. But that’s just one half of the equation. If your home value rises due to capital growth, your LVR may actually go down faster than you thought.

As a result, refinancers may enjoy a unique edge when it comes to LVR. Since you’ve paid off more of your mortgage and property prices tend to rise as a rule, you may qualify for betters interest rates than you think! In fact, CoreLogic reports that home values rose +0.9% in Australian capital cities over July – the fifth consecutive month of growth this year.

A property valuation can help you determine how much your home is worth. Once you know what you’re sitting on, you can compare the amount left on your loan balance.

Refinancing down LVR tiers can be a significant way to save money on your interest repayments. Generally speaking, low LVRs get lower interest rates than high ones. 

Here is a breakdown of the average variable interest rate for different LVR tiers in the Mozo database, assuming a $500,000 owner-occupied loan with 20 years left on its term making principal & interest payments.

Savings by LVR tier – 9 August 2023

The differences in overall cost are more subtle for LVRs below 80% than they are above 80%. Even just dropping down from 95% to 90% could save you up to $75 per month – and $18,031 over the lifetime of your home loan.

So how can refinancers turn their new LVR knowledge into a cost-saving hack?

The first step is to know your LVR before submitting a refinance application. Knowing this number can assist you in comparing home loans, since you know what you can qualify for and can suss out the interest rates and potential savings between offers. 

If your LVR is higher than you thought (perhaps you’ve accidentally slid into negative equity), it could be wise to lower it if you can before refinancing. The most common ways to reduce your LVR include:

• Boosting your home’s value through home improvements and renovations. One study found that adding energy-efficient features like solar panels can add up to 10% to a property's price. 
• Paying off your mortgage through making extra repayments, if your home loan allows this. 

However, both of these options require you to fork out a little money. If you’re refinancing because you’ve hit mortgage stress, it may not be worth it to add to your cost pressures. Consult a financial adviser to see if these tactics could be right for you.

Compare refinance home loans in the table below.