A loan-to-value ratio (LVR) is the percentage of how much you’re borrowing in relationship to the value of the property you’re buying, at the time of buying it. The key principle is the larger deposit you make, the lower the LVR becomes.
An LVR is all about risk. It’s the risk that a lender takes in giving borrowers a mortgage over a particular property. The LVR helps lenders determine the risk associated with the loan. A higher LVR indicates a higher risk because the borrower has less equity in the property. If property values fall, there is a greater chance that the loan amount will exceed the property's value. And as with any risk, comes a related cost. This impacts buyers in four key areas:
- Loan approval
- Lenders Mortgage Insurance
- Interest rates
- Building equity
Loan approval
Lenders have maximum LVR limits for different types of loans and property structures, both in the property’s physical structure and in the type of ownership e.g. owner-occupied and investor loans. Depending on your deposit amount the set LVR limits may mean buying the property is not an option. Broader market conditions can impact the LVR limits. For instance, in a rising property market, lenders might be more willing to accept higher LVRs, whereas in a declining market, lenders might tighten their LVR requirements to reduce the risk.
Here's a brief overview of the LVRs that apply.
Owner occupied
Most commonly, the maximum LVR of 95% = 92% plus Lenders Mortgage Insurance capitalised to loan.
Some lenders may go higher.
First home buyers—owner occupied
Maximum LVR 95%
If you qualify for First Home Guarantee Scheme—no Lenders Mortgage Insurance.
Investor
Maximum LVR 90% = 88% plus Lenders Mortgage Insurance capitalised to loan.
Some lenders may go higher.
Lenders Mortgage Insurance
Lenders Mortgage Insurance (LMI) is for the lenders benefit (hence the name). And while it’s the lender that takes the policy out, it’s the borrower who pays the insurance premium amount at loan settlement. It’s a once off up-front payment that covers the lender for the life of the loan—therefore the insurance policy isn’t cancelled at any point, despite equity building in the loan over time and therefore lowering the LVR. The LMI policy isn’t transferrable between lenders. This is important to remember for any refinancing prospect. The LVR equation must be crunched again.
This once off up-front payment can be paid in one of two ways: a lump sum paid upfront at settlement, or by adding LMI to your home loan (called capitalisation or capitalised to loan). This of course increases your loan amount and total interest payable.
LMI can range from a $6,000 policy at the lower end of the scale for a property valued at $500,000 with a 15% deposit being paid (85%LVR); up to a $45,000 policy for a property valued at $1 million with a 5% deposit being paid[1]. Again, some lenders will waive this premium, if you’re a first home buyer with a maximum LVR of 85%. Also, some occupations will qualify to have the LMI waived at a maximum LVR of 90%.
As you can see, it’s an expense worth paying attention to.
However, a quick rule of thumb for buyers is if your deposit is 20% and over, LMI does not apply and therefore no cost/expense applies for the buyer to cover at loan settlement. And certain professions can be eligible for a LMI waiver with certain lenders read more here.
Interest rates
Borrowers with lower LVRs typically receive more favourable/competitive interest rates because the loan is considered less risky.
Conversely, higher LVRs may result in higher interest rates to compensate for the increased risk.
Building equity
A lower LVR means the borrower has more equity in the property from the start. Again, due to the deposit amount as a percentage of the loan. A lower LVR can provide greater financial security and more options for refinancing or borrowing against the property in the future.
However, the timing of any refinance is important. If you refinance with a different lender with less than 20% equity in your home, you may have to pay LMI again. This is because LMI is not transferable between lenders.
At Get Real Finance, we pay close attention to the LVR to ensure the loan terms are appropriate for the borrower's financial situation and the property's value. We often see people lose significant sums of money in these scenarios due to dealing with people with less experience or not getting professional advice. As always, book a call with your Get Real Mortgage broker.
[1]https://www.money.com.au/home-loans/lenders-mortgage-insurance
