What is a Loan to Value Ratio (LVR)?

When purchasing a home, you’ll likely need to take out a loan, but this loan is unlikely to be for the entire amount of the property purchase. Instead, it’s likely that you’ll have a deposit to pay, and the loan will cover the remainder of the amount. The size of your deposit can have a significant impact on a property purchase, and this is where loan to value ratio or LVR comes in – understanding this concept is an important part of getting on the property ladder.

What is loan to value ratio?

The LVR of your home loan is the loan amount expressed as a percentage of the value of the property you’re buying. The bigger your deposit is, the lower your LVR will be. Typically, banks consider LVR when assessing the risk of a home loan – the higher the LVR (or in other words, the lower your deposit), the more the potential risk to a lender. It may also be the case that loans with a higher LVR come with higher interest rates and repayments, and vice versa.

How is your LVR calculated?

When you apply for a home loan, your lender will typically obtain an independent valuation of the property you’re buying. The lender will then calculate the LVR on your home loan by dividing the loan amount by this valuation. This figure is then multiplied by 100, so that the ratio is expressed as a percentage. Here’s a hypothetical example – if you apply for a loan of $800,000 from the bank to purchase a house which is valued at $1,000,000, the LVR would be 80%.

The difference between the size of your home loan and the value of the property you’re buying is typically made up of your home deposit. Generally speaking, the larger the amount you have available as a deposit when purchasing a property, the smaller the amount of money you will need to borrow for your home loan; therefore, the lower the LVR. The reverse of this is also true.

What is the difference between bank and market valuation?

The bank valuation of a property is an independent valuation carried out at the request of a bank or lender, in order to ascertain the value of a property. It may be different to the market valuation, which is an estimate, sometimes given by a real estate agent, of what they believe a property might be worth in the current market.

According to Westpac, banks typically carry out an independent valuation of a property when calculating LVR as a form of risk assessment, to ensure that they do not lend more than the property is worth. Before approving a home loan, banks want an estimate of what they might be able to recover if they have to sell the property, in the event that a borrower is no longer able to make their mortgage repayments.The bank valuation is used when determining LVR.

How does your LVR affect how much you can borrow?

Generally, a lender will only let you borrow as much as they think you’ll be able to repay. The LVR on a proposed loan is one of the factors that helps your lender assess your capacity to pay back the loan you’re applying for. This, in turn, protects borrowers against the risk of getting into financial hardship, and protects banks from the risk of a borrower defaulting on their loan. Therefore, most lenders have a maximum LVR they’ll approve on their home loans.

For example, if a hypothetical loan has a maximum LVR of 80% and the property you wish to purchase is valued at $800,000, the most that the lender would let you borrow would be $640,000.

Financial institutions also typically do not lend more than the value of the property, as they must ensure that selling the property will recover the full amount of the loan if you can’t meet your repayments are not met.

What happens when LVR is greater than 80%?

While you can still get a home loan with an LVR of greater than 80%, there may be conditions attached, and one of the most common of these is lenders mortgage insurance (LMI). LMI is effectively a form of insurance that protects lenders in the event that borrowers cannot meet their required repayments on a home loan. If your LVR is greater than 80%, your bank or lender may consider you risky as a borrower, and may therefore charge you LMI.

LMI is either paid as an upfront fee, or capitalised into a home loan, in which case, interest is charged on it. It is worth noting that there are some programs in place to assist prospective homebuyers who do not have a 20% deposit saved up. For example, the First Home Loan Deposit Scheme (FHLDS) can allow buyers to purchase a home with as little as a 5% deposit, although places in the program are limited.

Are there home loans with 100% LVR?

Some lenders may be willing to lend you 100% of the value of a property or even above if you are applying with a guarantor; however, it will depend on the individual lender. A guarantor is a person such as a family member or close friend who agrees to ‘guarantee’ your home loan, effectively taking responsibility for making the repayments if you are unable to. It is worth keeping in mind that guarantor home loans are especially risky for the person who agrees to act as guarantor, as they are potentially putting their assets and savings on the line.

What are the risks of high LVR home loans?

If you are considering taking out a home loan with a high LVR, in addition to the possibility that you will have to pay LMI, there are a number of other things to be wary of. These include higher interest rates, higher repayments, and greater scrutiny on you as a borrower.

• Higher interest rates: The higher the LVR, the higher the interest rate a bank might charge on a home loan, to offset the perceived risk.
• Higher repayments: The higher your interest rate, the greater the amount you will have to repay on your home loan, especially if LMI is factored in.
• Greater scrutiny: If you apply for a loan with a high LVR, your bank or lender may want to take an in-depth look at your finances to assess the risk of lending to you.

How can your LVR affect your deposit?

If you’re not sure how much of a deposit you might need to save up, you could calculate it based on the maximum LVR available on a home loan. For example, if you wanted to purchase a property valued at $800,000 and the lender stipulated a maximum LVR of 80%, you would need a deposit of at least $160,000 to be eligible for that loan. However, if the maximum LVR for the loan were 60%, you would be required to have a deposit of at least $320,000. Bear in mind that the property value a lender uses to calculate your LVR may not necessarily be the same as the listed purchase price. If you’re curious, you can read more about the kinds of property valuations that are available.

Cover image source: G-Stock Studio/Shutterstock.com. Original story by Eliza Parry Okden.