What is LVR (loan-to-value ratio)?
When it comes to home loans, a term that appears frequently is the loan-to-value ratio, often shortened to ‘LVR’. So what does it mean? Here’s what you need to know about LVR before you buy a home.
Put simply, LVR is a percentage showing the ratio of the borrowed amount to the value of the property. It’s commonly used by lenders to assess the risk of a home loan.
A high LVR can suggest a higher level of risk to the lender.
If a lender needs to sell a property with a high LVR because a borrower can’t make repayments, there is a higher risk that the sale price might not cover the amount borrowed. This means the lender would not recover the full loan amount.
Likewise, a property with a lower LVR represents less risk to the lender, as the market value is more likely to cover the cost of the loan if the bank needs to sell on behalf of the borrower.
Why is this important to you? A lower LVR usually translates to a lower interest rate for the borrower.
How is LVR calculated?
You can calculate the loan-to-value ratio by dividing the loan amount by the bank valuation – the value the lender calculates for the property (this may not necessarily match the market value – more on that below).
Here’s an example. Let’s say you pay $500,000 for a property and borrow $450,000 with a deposit of $50,000. Your LVR would be 90%. On the other hand, if you borrowed $400,000 with a deposit of $100,000, your LVR would only be 80%.
Let’s break down the first example of 90% LVR:
- Dividing $450,000 by $500,000 will give you 0.9
- Multiply by 100 to get a percentage (0.9 x 100 = 90%)
- The LVR will be 90%.
In addition to the initial deposit, keep in mind that there may be other costs to factor in when buying a home, such as stamp duty and legal costs. Read more about the upfront costs involved in buying a property.
Which property value is used – the market value or bank value?
Sometimes, there is a difference between what a property is expected to sell for (market value) and the value a lender estimates for it (bank valuation).
Market values are usually calculated using current sales trends in the surrounding areas. They’re used only as an indication for how much the property could be sold for.
A bank valuation reflects longer-term sales history as well as current market trends, in addition to other factors. It also reflects what the lender expects to recover from the sale of the property if the borrower defaults on the home loan.
A bank valuation is typically more conservative than the market value, because it lowers the risk of the loan for the lender.
If your bank valuation is lower than the current market value, you may need to add more to your deposit to make up the shortfall. In practical terms, this means if you want to buy an apartment for $500,000 and you have a $50,000 deposit, but your lender only values the apartment at $450,000, you’ll need to come up with an extra $50,000 to cover the difference.
Fortunately, in most cases your lender will order a bank valuation during the cooling off or finance period, so you will know before you purchase the property whether there is any shortfall you need to cover. If you’re buying at an auction, it’s vital you speak to your lender before you bid, as the bank valuation may only be calculated after the auction.
What if your LVR is over 80%?
When your LVR is more than 80%, your lender may require you to pay a fee known as Lenders Mortgage Insurance (LMI). LMI is designed to protect the lender if you can’t meet your repayments and default on your home loan. In such a scenario, should your property sell for less than what you owe, then LMI will cover the shortfall for the lender.
It’s important to understand that LMI is designed to protect the lender and not the borrower. The good news is in many cases the premium for your LMI can be added to your home loan, so it won’t need to be paid up front.
Using a guarantor
Having a friend or family member act as guarantor on your loan could help you buy a home with a LVR greater than 80% and without having to pay LMI.
At St.George, this is known as a Family Pledge loan. It allows a family member to use equity in their home to guarantee a portion of your home loan without having to pay any money for your deposit up front.
The higher the LVR, the higher the repayments
Repayments are often larger on home loans with a higher LVR. This may be as a result of the LMI premium being added to the loan amount or the lender charging higher interest rates to counter the risk of lending.
When working out what you’ll be able to afford in repayments, make sure you take into consideration any changes to your circumstances in the future. It’s also important to keep in mind that interest rates can fluctuate over time, which could also cause your repayments to change.
Here are four key points to keep in mind about LVR:
- LVR is a percentage showing the ratio of your borrowing amount to the value of the property you’re buying.
- You can calculate the LVR on a property by dividing the loan amount by the lender-assessed value.
- You will generally need to pay LMI if your LVR is 80% or more.
- A Family Pledge loan could allow a family member to act as guarantor if you need a loan with an LVR of more than 80%.
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This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness of the information to your own circumstances and, if necessary, seek appropriate professional advice.