What is Lending to Value Ratio (LVR)?
If there’s one equation you need to understand about home loans, it’s the Lending to-Value-Ratio (LVR). As the name implies, this is the ratio of the loan you want to take out versus the value of the property.
Why is the LVR so important? Your LVR paints a picture to the lender of the risk level of your property purchase. The higher the LVR is, the more ‘risky business’ you are.
Let’s look at an example of a home and calculate its LVR.
Say you’ve bought a home for $800,000 and put in a deposit for $170,000, which means you’ve borrowed $630,0000.
LVR = ($630,000 loan ÷ $800,000 home) x 100 = 78.75% LVR
So what does this mean anyway?
An LVR of 80% or less is a great sign (and green light) to lenders. By having at least 20% equity or ownership, it’s far less likely that you’ll end up owing more than value of the home.
What happens if you go above 80%?
If your LVR is above 80%, you are more likely to face a higher interest rate, as lenders want to attract customers deemed low risk with competitive rates. However, the drawcard is the Lender’s Mortgage Insurance, which can set you back tens of thousands of dollars. The amount varies between lenders and where you plan to buy, but it is usually anywhere between 1 – 5% of the property value.
Let’s go back to the example before. If you saved up $120,000 to buy a $800,000 property, your LVR would now be 85%. According to the Westpac LMI calculator, your LMI is estimated to be $27,140 in Victoria, which is around 3.4% of the property value.
Why do banks charge you the LMI? When you borrow significantly more than what you have, the banks see you as higher risk and so this fee acts as a compensation to them. The LMI will provide your bank insurance against a financial loss if you fail to pay back on the loan.
A workaround to an LVR higher than 80% is to find a guarantor, such as your parents or relative who can provide their property as a security on your home loan. By doing this, you will be able to borrow 100% of the property value without being charged LMI. From the bank’s perspective, you are borrowing less than 80% of the combined value on both properties, so no LMI is needed.
Paying for the LMI is not all bad news if it helps first home buyers get a foot into the property market. First home buyers may be eligible for the First Home Loan Deposit Scheme (FHLDS). This scheme enables first home buyers to buy a home with a deposit as little as 5%, without needing to pay the LMI.
As you can see, LVR is an integral part of determining how much you should borrow and the value of the home you’re looking for. For a $800,000 home, your safest bet is to have $160,000 saved up in order to avoid the LMI.
At the end of the day, it’s important to remember that the home loans market is competitive and constantly changing.
Speak with your mortgage broker who can give you the latest update on the home loan market and recommend the best value loans for your circumstance.
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