Understanding the Loan to Value Ratio (LVR) is crucial when you’re searching for home loans. LVR calculates the proportion of money you intend to borrow against the property’s value, expressed as a percentage. This figure is important for lenders, as it helps them in assessing the level of risk associated with a loan.
Lenders typically enforce strict LVR thresholds as part of their lending criteria, favouring an LVR of 80% or below. This implies that borrowers are generally required to provide a minimum deposit of 20% of the property’s value to qualify for most loans.
Borrowing with a smaller deposit significantly increases the lender’s risk. While some lenders may choose to reject mortgage applications with low deposits, others may require borrowers to pay for Lenders Mortgage Insurance (LMI) to reduce their perceived risk.
How is LVR calculated?
LVR can be calculated by dividing the amount of money you plan to borrow by the value of the property, multiplied by 100. So, if you want to borrow $600,000 for a $800,000 property, your LVR would be:
($600,000/$800,000) 100 = 75%
You can also calculate your LVR as the portion of the property’s value that’s not covered by the deposit. If you’re making a deposit covering 25% of the property’s value, your LVR is 75%.
It’s important to note that lenders don’t always use a property’s market value when calculating LVR but its appraised value. Banks and lenders value your property through a formal appraisal process, which may involve a physical inspection or rely on property data.
This valuation considers factors like location, size, condition, and recent sales of similar properties. Lenders typically use this value for calculations to ensure they don’t lend more money than what they might be able to recover if they need to sell the property.
How does LVR affect your mortgage application?
LVR plays a crucial role in the mortgage approval process. For home loan eligibility, the majority of lenders require a minimum 20% deposit from borrowers, corresponding to an LVR of 80% or lower.
A high LVR loan is perceived as a greater risk by lenders, which may, in turn, lead them to reject a mortgage application. Some lenders might be willing to take on the risk, but they are likely to charge a higher interest rate or require LMI.
It’s vital to recognise that LVR is just one of many factors influencing your loan application’s success. A stable income and strong credit history can sometimes offset the need for a large deposit or help you avoid LMI, particularly for individuals in certain professions, such as doctors, lawyers, and accountants. Speak to a mortgage broker to find out more about LMI waiver and low deposit home loans.
Risks of high LVR loans
Even though it may be possible to take out a home loan with a high LVR, it’s not necessarily a good thing. Apart from the possibility of paying thousands of dollars extra for LMI, there are additional risks you should be aware of.
A higher LVR often leads to higher interest rates, thereby escalating your loan’s overall cost. Moreover, borrowing a larger portion of your property’s value leaves you with minimal equity. In the event of a decline in property values, you could find yourself in a situation of negative equity, owing more than your home is worth.
Tips to reduce your LVR
Lowering your LVR can help improve your loan terms and save you money. Here are some tips:
- Save a bigger deposit: The more you save for your deposit, the less you’ll need to borrow, lowering your LVR.
- Buy a less expensive property: Opting for a property with a lower price can also reduce your LVR.
- Make extra repayments: If you’re refinancing, making extra repayments to reduce your principal can lower your LVR. You could also make improvements to your house to increase its value.
- Get a guarantor: Having a family member guarantee your loan won’t directly reduce your LVR, but it can help you borrow money without any significant deposit or paying for LMI.