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.
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 (through a home 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. Lenders Mortgage Insurance (LMI)).
What is a good loan-to-value ratio?
A good loan-to-value ratio (LVR) depends on what you’re after. A loan-to-value ratio of 80 or lower (20% deposit or higher) means you don’t pay the expensive lenders mortgage insurance, but can be hard to save up for.
An LVR of 85, 90 or 95 means your initial deposit is much smaller, but can make your loan more expensive.
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, 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 lower interest rate to borrowers with lower LVRs. Why? Because these borrowers represent less risk to lenders. A low LVR means the property should be worth considerably more than the debt that’s owed, so if the borrower were to default on the loan, the lender will have a good chance of recovering their debt by repossessing the borrower’s property and selling it.
Along with potentially having a higher interest rate, borrowers with a higher LVR can also be hit with 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.
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 hit with an LMI premium of $7,776.
Here’s a quick look at what you might expect to pay for LMI based on varying house prices and LVRs:
Estimated Lenders Mortgage Insurance (LMI) Premiums for First Home Buyers
|Estimated property value||95% LVR||90% LVR||85% LVR|
Source: Genworth LMI premium estimator. Prices including GST but excluding stamp duty. Based on a loan term up to 30 years.
So if you want to avoid LMI and put yourself in a good position to qualify for lower interest rates, you could aim to have a lower LVR by buying a property in a lower price bracket or waiting longer to save up a bigger deposit. But this isn’t practical for everyone.
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.
Do you always need a lower LVR?
There are good reasons why you’d want an LVR of at least 80%. As discussed above, a 20% deposit or greater can help you secure a lower interest rate and more favourable lending conditions, which in turn can seriously reduce your monthly interest repayments. Plus, you can potentially save yourself thousands in LMI premiums.
But sometimes an 80% LVR might not be practical. Saving for a house deposit can take a long time – up to 8 years in Sydney – and over this time the value of the house you’ve got your eye on can increase significantly. A $25,000 LMI premium could look like pocket change compared to a $100,000+ increase in the capital value of the house, and you’d be kicking yourself if you missed out on this opportunity because you wanted to wait for a higher deposit. So sometimes it’s worth just jumping in with a 5-15% deposit since you can potentially gain far more from selling a house than you’d have to pay an LMI premium plus a slightly higher interest rate.
Just make sure your interest rate isn’t too much higher – an interest rate that’s 100 basis points higher can result in tens (if not hundreds) of thousands more being paid in interest over the life of the loan.
100% LVR: the maximum loan-to-value ratio
It’s possible to get a loan without paying a deposit on your home – that’s a 100% LVR – but not by yourself. You can get a 100% LVR home loan through the use of a guarantor, which is someone (usually a parent) who agrees to take responsibility for repaying the home loan in the event you fail to make the repayments.
This is quite risky on behalf of the guarantor, so it’s not a decision that can be made lightly. But by making extra repayments on your mortgage or having the value of your property increase, the guarantor may become unnecessary.
Guarantor home loans are popular among first home buyers or people with lower incomes who struggle to afford a housing deposit.
Frequently asked questions
You can refinance a home loan with any Loan-to-value ratio (LVR) based on the lender itself, but you should generally try and aim for equity of at least 20% of the property’s value.
The LVR (loan-to-value ratio) formula is fairly straightforward to calculate: The LVR is how much of the property you still have to pay off.
LVR = 100 – deposit size.
For example, a 20% deposit will give you an LVR of 80.
Savings.com.au’s two cents
The LVR, or loan-to-value ratio, is indicative of how much of the property’s value you have to repay to the lender. A higher LVR can cost you more over the life of the loan because:
- You may have a higher interest rate
- You may have to pay LMI
- You’re borrowing more for the property
But as discussed, it’s not always practical or economical for someone to hold off buying property until they have an LVR of at least 80%, because property prices may rise significantly over the time it takes to save up a 20% deposit.
So in general, aim to have an LVR of at least 80%, but consider whether you can afford to wait.