What is loan-to-value ratio?
One of the common terms that you’ll come across in the home loan market is loan-to-value ratio, or LVR. But what does it mean, exactly?
LVR is the ratio of the amount you are borrowing to the value of the property you wish to buy, expressed as a percentage. Lenders commonly use the LVR to assess the risk of a home loan. A higher LVR represents a higher level of risk to the lender and can affect your borrowing power and home loan application.
Once the LVR exceeds 80% it’s generally considered high and the lender will require Lender’s Mortgage Insurance or a guarantor to offset their risk.
How to calculate LVR
You can calculate the LVR by dividing the amount you are borrowing by the bank’s valuation of the property (this is not necessarily the same as the market value – but more on that later).
For example: Let’s say that the property you wish to buy is valued at $1,000,000 and you have a deposit of $100,000, so need to borrow $900,000. In this case your LVR would be 90%.
But if you borrowed $800,000 with a deposit of $100,000, your LVR would go down to 80%.
Here’s a breakdown of how to calculate the LVR:
- Divide $900,000 by $1,000,000 to get 0.9
- Multiply by 100 to get a percentage (0.9 x 100 = 90%)
- The LVR will be 90%.
When figuring out your deposit amount, keep in mind that you may have to pay other upfront costs associated with buying a home, such as stamp duty and legal fees. Read more about the upfront costs involved in buying a property.
Market value or bank value – how are they different?
If you’re buying a home for the first time, you may not realise that the market value of a property is often different to its value as assessed by the bank.
A market valuation is an estimate of how much the property will sell for on the real-estate market. It’s based on recent sales data rather than long-term trends and also assumes that the seller is willing to wait to get the best price on their home.
A bank valuation is performed objectively by a professional valuer. It is typically more conservative than the market value because the bank has to ensure that they don’t lend more than the value of the property.
The bank valuation is an estimate of what the lender might be able to recover from the sale of the property in the event that the borrower can no longer make repayments on the home loan.
What does it mean when LVR is more than 80%?
When the LVR on a loan is more than 80%, your interest rate may be higher. Additionally, you will generally need to pay for Lenders Mortgage Insurance (LMI).
LMI is an insurance designed to protect the lender if the borrower can’t meet their home loan repayments. If this happens, the property securing the loan will need to be sold so that the bank can recover the debt. But sometimes the sale price of a property won’t be enough to pay what’s owed and, in these cases, LMI will cover the difference.
It’s important to note that while you, the borrower, pay for LMI, it only protects the lender (not the borrower) against financial loss. On the bright side, LMI allows you to buy a home sooner if you have a high LVR. In many cases the cost of LMI can be included in the amount you borrow, so you won’t need to pay for it up front.
Other challenges of a high LVR
Apart from the cost of LMI, there are some other downsides associated with high LVR loans:
- Higher interest rates – the lender will often charge higher interest rates to lower the risk of lending.
- Higher repayments – when LMI is added to your loan amount it increases the amount you are borrowing, resulting in higher repayments. Higher interest rates will also result in higher repayments.
- Application scrutiny – with a high LVR your application may be scrutinised more closely to make sure you will be a good borrower.
When thinking about what you can afford in repayments, it’s important to take into account any possible changes to your circumstances in the future. Keep in mind also that if interest rates vary over the term of your loan, this could change the amount of your repayments.
How to reduce LVR
If you want to decrease your LVR (and avoid paying LMI), a family member may be able to help.
By using a portion of the equity in their home to guarantee part of your loan, a family member can help you buy a property sooner and without the extra cost of LMI. At Westpac, this is known as a Family Security Guarantee.
Another option to reduce your LVR is simply to continue saving until you have a larger deposit. It may be worth saving more aggressively for a period, if it means lowering your LVR and saving on LMI and higher interest. You could also consider buying a cheaper home in order to get a foothold in the market.
Here are some key points to remember about LVR:
- LVR is the ratio of your loan amount to the value of the property you’re buying, shown as a percentage.
- To calculate LVR, divide the amount of the loan by the lender-assessed value of the property.
- If your LVR is 80% or more your interest rate may be higher and you’ll typically need to pay for LMI.
- LMI protects the lender, not the borrower.
- You might be able to avoid paying for LMI if one of your family members guarantees your loan.
Credit criteria, fees, charges, T&C's apply. The guarantor should consider the risks associated with Parental Guarantee, primarily that if the borrower defaults on their loan, the guarantor is liable to pay up to the maximum of the portion of security they have put forward as a guarantee. Westpac advises guarantors obtain independent legal advice.