When you are going through a loan application process with your lender, you’ll notice that banks and other financial institutions like to use a variety of abbreviated terms to describe a range of important elements of the transaction. The LVR or Loan to Value Ratio on your application is definitely one of these as it is a basic fundamental on which all home loans are assessed. That’s why it is vital that you acquaint yourself with its meaning and get a clear understanding of how it impacts your overall loan transaction.
So what exactly is LVR?
LVR or Loan to Value Ratio
Quite simply, your LVR is the amount of money you wish to borrow from the bank represented as a percentage (%) of the total value of the property you wish to purchase.
For example, if the property you would like to purchase is valued at $500,000 and the loan amount sought is $400,000 then your LVR will be 80%. This can be calculated as follows: $400,000 (loan) divided by $500,000 (property value) = 80% loan with a corresponding deposit of 20%.
Now it’s important to note that this percentage is extremely important when it comes to how the bank will evaluate your loan application. Because the lower your LVR, the lower the exposure to risk there is for the bank and therefore the more likely it is for your application to be approved, depending upon your capacity to repay the loan.
Why is your LVR so critical?
- How Much You Can Borrow: There are two important factors which determine how much money you can borrow. Firstly, the bank will look at your servicing capacity or ability to repay your loan and secondly, your equity in the property you wish to purchase which is represented by your LVR. Interestingly, whichever of these two is the lesser, will be the amount you can borrow. That’s why your LVR is key in determining how much you can borrow.
- Maximum LVR: Depending upon your lender and the loan product, financial institutions have what is known as maximum LVR These may vary, however as a rule of thumb the maximum LVR is 95% with a 5% deposit for residential property purchases, either owner occupied or investment properties. With refinancing most lenders will usually only go to 90% LVR, and for Low Doc Loans and Commercial loans this can be as low as 60-70% LVR.
- Lenders Mortgage Insurance: All loans over the 80% LVR threshold will incur a Lenders Mortgage Insurance (LMI) fee. This fee is enforced by the banks as a form of security should you, as a low deposit loan applicant, end up defaulting on your loan repayments. The higher the LVR, the greater the exposure to risk for the bank, the more expensive the LMI will be. Your LMI is determined by a sliding scale and gets more expensive the higher the LVR. It's important to realise that only the lender is covered by this insurance and even though you are paying for it, this offers no protection to you, the borrower.
- Lower Interest Rates: With a lower LVR you may also be offered a more favourable interest rate on your loan. This is because lenders are inclined to reward borrowers with lower LVRs, and the corresponding lower exposure to risk for the bank, with discounted interest rates. Depending on the lender these discounts can be quite substantial and provide you with significant savings across the life of your loan.
So, if you are considering a property purchase, feel free to give one of our Mortgage Coaches a call to discuss your specific circumstances and LVR position. You will be glad you did.
Until next time Champions,