In the home loan market, a common term you may hear is loan-to-value ratio, or LVR. We explain exactly what it is and how it can affect your home loan interest rate.
What is a loan-to-value ratio?
A loan-to-value ratio (or ‘LVR’ as it is commonly referred to in the industry) is the VALUE of a property in comparison to the amount of money being borrowed (in a loan) – calculated as a percentage. It is used by lenders to assess the risk factor of a loan. The lower your LVR percentage, the less of a risk that particular loan is to a potential lender.
Keeping track of your LVR when house hunting is important as it gives you a good indication of the buying power of the deposit that you’ve managed to save. A good LVR can also help you avoid certain fees that sometimes get applied to home loans (eg. LMI or ‘Lenders Mortgage Insurance’).
How to calculate your LVR
Lenders typically calculate your LVR by dividing the loan amount by the property’s value and multiplying it by 100.
For example, if John was looking at a property which had a valuation of $450,000 (not its price – but its value) and he had a $90,000 deposit, he would need to borrow $360,000.
By dividing $360,000 (the loan amount) by $450,000 (the valuation of the property), we get 0.8 which, multiplied by 100, means that John’s loan-to-value ratio is 80%.
How can LVR affect your interest rate?
LVR can affect your interest rate because many lenders actually apply a higher interest rate to higher LVRs. Not many people realise or understand this. If more people were aware of this, perhaps they would do more to reduce the amount of their loans (by potentially buying a property in a lower price bracket) and wait longer to build up the size of their deposit.
Another negative impact of a higher LVR is the application of Lender’s Mortgage Insurance, or LMI, which acts as something of a safety net to the lender should you be unable to make your monthly loan payments. It can vary in price depending on the lender and what LVR percentage you have, but can leave you out of pocket if you aren’t careful. The lending industry average LVR where LMI is applied is from approximately 80% and higher. And what does LMI cost? Of course, it is different for almost every loan but according to the Genworth LMI estimator, if you have an LVR of 90% on a $450,000 loan for up to 30 years, you could be paying an LMI premium of $7,776. That’s almost $40 per month extra on your loan repayments across the life of the loan!
Tim was looking at houses for $450,000 and had $22,500 in his savings. If he had calculated his loan-to-value ratio before applying for a loan, he would have discovered that he had an LVR of 95%. Because of this high ratio, the lender thought he was too high of a risk and rejected his application.
Tim decided against buying the house and saved up until he had $90,000 in his savings – which achieved an LVR of 80%. When he reapplied for the loan, it was approved by the lender and he didn’t have to pay any LMI.
House hunting can be a stressful time. Calculating your LVR can be a great way to guide you on the types of houses you can afford and potentially save you from any nasty surprises when it comes to applying for a home loan.