If you are taking the plunge and purchasing your first property, understanding mortgage jargon and concepts can be intimidating. One of the frequent terms that you’ll encounter is LVR or loan-to-value ratio, but how do you define LVR? And why is it important?
Loan-to-value ratio or commonly known as LVR is the amount you’re borrowing to the property’s value you want to purchase, depicted as a percentage. Lenders generally use the LVR to evaluate the risk of a mortgage. The more deposit you have, the lower your LVR will be. While a higher LVR signifies a top level of risk to the lender and may influence your borrowing capacity and mortgage application.
How to calculate LVR
LVR is calculated by dividing the loan amount by the purchase price of the lender’s valuation of the property you’re purchasing.
Say the property you want to purchase is priced at $1,000,000 and you have a $100,000 deposit, you want to borrow $900,000 – your LVR will be 90% in this scenario.
But if you only borrow $800,000 with the same $100,000 deposit, your LVR would drop to 80%.
When estimating your deposit, take on board other upfront costs that you may need to pay related with purchasing a property, in particular legal fees, stamp duty and conveyancing.
Market value or lender value – what’s the difference?
If it’s your first time purchasing a home, you may not notice that the property’s market value is usually not the same as the lender’s assessed value.
An estimate of how much a property will sell on the market based on surrounding property price movement is called a market valuation. Recent sales data is typically considered instead of ongoing trends and likewise presumes that the seller is eager to hang fire to win top dollar on their property.
A lender valuation is carried out independently by a qualified valuer. This valuation is often a more accurate representation of the property value, as the qualified valuer attends the property for a more thorough inspection. Lenders will typically accept these valuations over market estimates to calculate LVR.
In the event that the borrower fails or can no longer make repayments on the mortgage, the lender’s valuation will be used as an approximation of what the lender might be able to recuperate from the sale of the property.
What happens if LVR is above 80?
If the loan’s LVR is above 80%, your interest rate could be higher. You may also be required to pay for a Lenders Mortgage Insurance or LMI.
LMI is an insurance that protects the lender if the borrower defaults on a home mortgage that is deemed as “high risk”. In this scenario, the loaned property has to be sold so the lender may win back the debt. In some cases, the property’s sale price is not sufficient to settle what’s owed and as a result, LMI will insure the difference.
It’s crucial to understand that although the borrower pays for LMI, it only shields the lender (not the borrower) from financial loss. On a positive note, if you have a high LVR, LMI lets you purchase a property sooner rather than later. In most cases, LMI’s cost can be added to the amount you borrow, so you don’t have to pay upfront.
Other drawbacks of a high LVR:
Aside from the cost, here are several challenges related with high LVR mortgages:
- Steep interest rates– to reduce the risk of lending, the lender often impose higher interest rates.
- Exorbitant repayments– when your loan amount has an LMI affixed to it, the amount you’re borrowing increases, ensuing higher repayments. High interest rates equates to higher repayments.
- Probing application– Lenders may take a long hard look at your mortgage application if you have a high LVR to ensure you will not default in the long run.
It’s important to consider potential lifestyle or circumstance changes when checking what you can allot in repayments. Note that interest rates may fluctuate during the duration of your mortgage which can also alter your regular repayment amount.
How to minimize LVR
A family member could assist in reducing your LVR (and potentially avoid taking LMI). By using a bit of their home’s equity to guarantee a portion of your mortgage, a family member can help you to purchase a property sooner rather than later, without the added charge of LMI.
Another alternative to lessen your LVR is to keep on saving until you have a substantial deposit. You can definitely lower your LVR, avoid paying LMI and save yourself from getting a high LVR by vigorously saving.
Here are some LVR key details worth remembering:
- LVR is the proportion of your loan amount to the property’s value you’re purchasing, displayed as a percentage.
- To compute LVR, divide the loan amount by the property’s lender-estimated value.
- Your interest rate will be higher and will usually pay for LMI if your LVR is above 80%.
- The lender is protected by LMI, not the borrower.
- You can avoid paying for LMI if you save for a bigger deposit or a family member guarantees your mortgage.