Loan to value ratio: What is LVR?
When it comes to taking out a home loan in Australia, one of the common terms you’ll see sitting within the mortgage product information is “LVR". But if you’re one of the many home hunters wondering “what is LVR?” and have no clue what the abbreviation stands for, let this quick guide answer the question.
LVR means loan-to-value ratio and is used by home loan lenders to assess how risky you will be to lend to and whether they will approve you for their home loan. If you have a high LVR, this means you will be borrowing a large amount of the property value, so your repayments will be higher than someone with a larger deposit and lower LVR.
Let’s use the example of first home buyer Hannah who has saved a deposit of $80,000 and is looking to purchase a property with a value of $500,000. To figure out her LVR, Hannah will have to conduct some simple maths. Here is the LVR calculation she will need to use:
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LVR calculator: home loan amount ÷ property value = loan to value ratio
Hannah can calculate her “home loan amount” by deducting her deposit from the overall property value.
$500,000 - $80,000 = $420,000
Next she’ll need to use the above LVR calculation to see what her loan to value ratio is:
$420,000 (home loan amount) ÷ $500,000 (property value) = 0.84
The last LVR calculation she’ll need to do is times 0.84 by 100 to find the percentage figure.
0.84 x 100 = 84% LVR
Voila! Hannah’s LVR is 84%. But since she has a deposit of less than 20% and will be borrowing more than 80% of the value of the property, she will have to pay lenders mortgage insurance, which is an insurance home loan lenders in Australia take out for low deposit loans as protection in the case the borrower fails to repay the loan.
Often lenders mortgage insurance is confused as protecting you the borrower, but in fact LMI is only an insurance that covers the provider. So if you wanted financial protection in the case you became unwell or injured and were unable to work, you would need to look at taking out mortgage protection insurance. This covers the cost of your home loan repayments for a set period of time specified in the policy.
Back to our case study Hannah. There are several ways she can avoid the cost of paying lenders mortgage insurance on her first home loan.
- Save a larger deposit: While Hannah currently has a deposit of 16%, if she could hold off purchasing her first home and save up an extra $20,000 this would make her loan to value ratio 80% and she would avoid the cost of lenders mortgage insurance.
- Parental guarantor: Hannah could ask her parents to go guarantor on her home loan by putting their own property up as a guarantee. While this will save her tens of thousands on LMI, if Hannah was unable to repay the loan the lender has the right to seize her parent’s asset and sell it to recover their loss. So if you’re thinking of asking your parents or another family member to be a guarantor, make sure they know the risks involved before they sign in.
- Add the cost to her home loan. Another option for Hannah is to add the cost of lenders mortgage insurance to her home loan and ensure her mortgage has the option of fee free extra repayments so when she comes into extra cash down the track she can pay off this amount quick smart to avoid the additional interest the LMI will cost her over the life of the loan.
What are the LVR traps to watch out for?
Lenders mortgage insurance isn’t the only factor to consider when it comes to your LVR, here are a few more to keep in mind...
1. Higher interest rates for low deposit loans
You might be eager to get a foot in the property door but there are some benefits of waiting until you’ve saved up a sizeable deposit and one of the main pros is a better interest rate. Many lenders use a tier based interest rate system, which means the lower your LVR and higher your deposit the better rate you’ll receive.
For instance, take a look at the different rates available with the AMP Variable Rate Loan (Professional Package):
|LVR||Loan amount||Interest rate|
80% or less
90.00% or less
Between $250,000 - $499,999
90.00% or less
* Rates taken 9 July 2015.
As you can see from the above table your interest rate will not only depend on your LVR but the amount you’re borrowing too. So when you begin your home loan search don’t just compare by the headline rate, check which tier bracket you fall under to ensure you get the best deal for your situation.
2. Stricter lending requirements for investor loans
While there are low deposit home loans available, we should mention that LVR requirements are different for property investors.
Let’s use another example but this time look at first time buyer George, who is aiming to purchase an investment property, which he will rent out to tenants to cover the majority of his mortgage repayments.
Unlike Hannah who will be able to borrow up to 95% of the property value as an owner occupier, George will have to adhere to stricter investor lending requirements, which generally will only allow him to borrow up to 80% of the property value.
The reason banks are cracking down on investor loans and are introducing stricter LVR requirements is largely due to pressure from the Australian Prudential Regulation Authority (APRA), which says lenders shouldn’t be increasing their investor home loan portfolios by more than 10% in a year.
3. Cost of switching home loans with a high LVR
As you’ve probably heard, once you’re signed up with a home loan it’s important to keep an eye on the mortgage market and make the switch every few years or so if you find a better deal. However, there's one major gotcha when it comes to refinancing that could cost you big bucks - repaying lenders mortgage insurance.
So if you want to switch providers down the track, make sure you get a professional valuation from your bank (not your real estate agent as they can only give you an estimate), so that you know exactly what your loan to value ratio is. If you have an LVR over 80%, this could negate the savings made by refinancing, as you’ll have to pay lenders mortgage insurance again.
How can I decrease my LVR?
Your LVR reflects the amount borrowed as a percentage of the value of the property you’re buying, so if you want to lower your LVR, you can do so by saving up a larger deposit, or by looking at cheaper properties.
How does the bank value my property?
If you’re buying a property, refinancing or accessing the equity in your home, your bank will insist on conducting a property valuation. This is so the bank can be confident that if you’re unable to pay back the loan, they can sell the property and recover the amount owed.
The valuation itself isn’t usually done by the bank. Instead, it’s outsourced to an independent valuer, who might inspect the property in person and produce a report based on the location, size and condition of the building.
Others might rely on less time-consuming methods to appraise your property, such as a desktop valuation (comparing data from similar sales) or a restricted assessment (inspecting the property from the street).
Keep in mind that a bank’s valuation is not the same as the market valuation. The former is done for credit assessment purposes, and tends to be much more conservative than the amount the market might deem your property worth when listed.
Will I have a different LVR if I’m refinancing?
If you’re refinancing, your LVR will look a little different compared to when you first took out a loan. For starters, depending on how far into the loan you are, the outstanding balance will have decreased. On top of that, your property’s current market value might have changed since you bought it.
Is a lower LVR better?
Generally, a lower LVR will be preferable because it means you have less to pay off and are therefore closer to owning your home. You’ll also have more equity in your property (the market value of your home minus the amount of the loan still owed) from the get-go.
Having a deposit of at least 20% of a property’s value saved up will also allow you to avoid having to pay Lenders Mortgage insurance, which is required on high LVR loans to protect the lender in case you default. In the eyes of a lender, a lower LVR represents less risk, which is also why many lenders offer more attractive rates to borrowers with an LVR below 80%.
Are you purchasing your first home? If so, then our first home buyers hub, which is full of helpful tidbits to make purchasing property a breeze, should be your next stop.
Want to speak to one of our experts? Give our home loan negotiator a buzz on 13 6696 (MOZO) or submit an online enquiry and we’ll answer any questions you have about navigating the property maze and haggle a great deal on your behalf.
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