Home loan-to-value ratio vs. home equity: what’s the difference?

Your loan-to-value ratio (LVR) and home equity are vital parts of your mortgage. Home equity can be an untapped source of wealth used for everything from a home loan deposit to funding for renovations, while your LVR tier can set the interest rate on your mortgage repayments.

But few borrowers understand what these home loan terms mean and how they compare. So let’s break it down. What’s the difference between your LVR and your home equity? And why are they important?

The loan-to-value ratio, or LVR, is the size of your home loan divided by the value of your property. In other words, it's what you need to borrow over how much the property is worth. 

Loan value ÷ home value = LVR 

LVR is typically expressed as a percentage. To get a percentage, just multiply the decimal by 100. 

(Loan value ÷ home value) x 100 = LVR %

Your LVR can vary based on the size of your home loan deposit or how much of your mortgage you’ve paid off. Because of this, your LVR is a vital number to know for home loan applications, whether you're a first home buyer or refinancing. 

LVR also helps lenders determine your financial risk. If you have a small deposit (less than 20%), your LVR will be high, which means you could cop a higher interest rate and the added cost of Lenders Mortgage Insurance (LMI). The opposite is also true: the lower the LVR, the lower the interest rate.

Home equity is the difference between what your property is worth and how much you owe on it, such as outstanding loans. Essentially, home equity is the value of your financial stake in your home.

Home value – loan value = equity $

Equity is usually expressed as a dollar value, but it can also be expressed as a percentage, i.e. what percentage of your home’s value you own. You could say, “I have 20% equity in my home” or “I have $20,000 equity in my home” and they describe the same thing.

To get your percentage equity, use this formula instead:

(Equity $ ÷ loan value) x 100 = equity %

Your home equity is important because it gives lenders an idea of how in debt you are, as well as provides you with a source of wealth you can unlock to do things like invest in another property or refinance your mortgage. 

Rising or falling property prices can affect your home equity, since your home’s value isn’t static. If your property gains value, then your home equity increases; if it loses value, you lose equity. 

Losing too much value (called a capital loss) can also slide you into negative equity, which is when you owe more on your home than what it’s worth. This can be one of the worst case scenarios when paying off your home, potentially landing you in a home loan hostage crisis or mortgage prison.

Theresa wants to buy a home worth $500,000. She applies to a lender and with $100,000 in savings: enough for a 20% down payment (not including any fees or stamp duty costs).

Because she’s covering the first $100,000 needed to buy her home, the actual value of her loan will only be $400,000. Her LVR will therefore be 80%. 

($400,000 ÷ $500,000) x 100 = 80%

Because Theresa will own 20% of the home outright, her initial equity is 20%, or $100,000.

$500,000 – $400,000 = $100,000

($100,000 ÷ $500,000) x 100 = 20%

However, an overnight housing boom in Theresa’s new neighbourhood drives up her property’s value. Now, her home is worth $600,000. How does this affect her equity and LVR?

($400,000 ÷ $600,000) x 100 = 66.7% LVR

$600,000 – $400,000 = $200,000 equity

Having a lower LVR could make her eligible to refinance to a lower interest rate, which can save her money on her mortgage repayments. She could also leverage her equity to finance an investment property, if she chooses.

To calculate your LVR and equity, you’ll need to know two critical pieces of information: how much your property is worth and the amount of debt you have on it (including mortgages and personal loans). 

A property valuation can help establish what your home is worth. Your lender will also need to agree on the property value before approving your home loan or refinance application.

Once you know your property value and how much you owe, just use the formulas. 

Loan value ÷ home value = LVR

Home value – loan value = equity

A financial planner can walk you through these numbers and how you can best use them for your personal finances.

Compare low interest rate home loans below.