While saving for a home deposit is undoubtedly challenging, decoding home loan jargon can prove almost as difficult! From caveats to capital gains tax, you may feel like you need an encyclopaedia just to get through a meeting with your lender. But while not all home loan terminology is going to be relevant to your personal situation, there’s one that all home-buyers should familiarise themselves with: the loan to value ratio, or LVR.
No matter what type of property you’re buying or where in Australia you live, this is a concept that applies to anyone taking out a mortgage. Read on for your guide to the loan to value ratio, including what it is, how to calculate it and what it means for borrowers.
The loan to value ratio (LVR) is a term commonly used by lenders to determine your borrowing power. Essentially, it’s the amount you need to borrow, calculated as a percentage of the current value of your home.
The higher the LVR, the greater the risk to a lender. Consequently, lenders look for LVRs that are around 80% of the property’s value or lower. Home loans under 80% of a property’s value typically won’t attract Lenders Mortgage Insurance (LMI). However, those over 80% will have to pay this insurance, unless they can offer assets as security over the loan.
So, how is the LVR calculated, exactly? In order to calculate LVR on a mortgage, lenders must first determine the value of your property. They do so by carrying out an independent valuation of the property. They then divide the loan amount by the value of the property and multiply it by 100 to get a percentage.
For example, if the lender valued your property at $300,000 and you have a $270,000 loan amount, you would calculate your LVR like this:
$270,000 300,000 = 0.90
Therefore, your LVR would be 90%
You can use this loan to value calculator to help you determine your LVR.
Lenders use independent valuers to give them an accurate and unbiased appraisal of a property’s value. There are a few factors lenders use to determine how much a property is worth. These include property type, age and condition and geographic location, as well as current market conditions and zoning restrictions. There are also three different types of valuations.
Full valuations: This involves a full, in-person inspection of the home. It’s generally used in scenarios where there is a higher risk to the lenders, such as high loan amounts, more complex transactions or properties in areas where there was been a rapid increase in property prices that may not be sustainable.
Curbside valuations: This is essentially a ‘drive-by’ valuation of the property, where the lender will examine the condition and location externally from the street. This is generally used in situations with a lower loan amount, where no lenders mortgage insurance will be paid.
Desktop valuations: This is when no inspection of the property is carried out and the lender calculates the LVR using the median price of the property. It’s generally used in capital cities and with low loan to value mortgages.
Not all lenders will ask for a full property valuation, which typically cost between $250 and $450 each. Some lenders won’t worry about a property valuation if the property already satisfies their lending criteria. Other lenders will use a desktop or computer-generated assessment.
A lender usually orders a property valuation if:
You may be wondering, what happens if the actual purchase price of your home is different from the lender’s valuation? Generally, the lender will use whichever amount is lower to calculate your loan to value ratio.
This occurs most commonly when a property has been purchased off the plan and the value has gone up or down since the contract was signed. It can often happen in situations of favourable purchase, which is when someone is purchasing a property off their family as a discounted price.
While some lenders will allow you to borrow up to 90 to 95% of your property’s value, you will begin to accrue LMI (Lenders Mortgage Insurance) once you surpass 80%.
The amount you need to pay in Lenders Mortgage Insurance depends on a number of factors, including:
To get an estimate for your LMI premium, multiply your LMI rate your LMI rate by your loan amount.
For example $90,000 x 0.932% = $838.80. Then, add the applicable stamp duty on LMI for the state you are buying the property in.
So, what is the maximum loan to value ratio? Turns out, some lenders will allow you to borrow 100% LVR if you have a guarantor to support the application. This would involve using a family member or friend who owns a property to use it to secure the higher home loan.
The lower your LVR, the less risk your loan presents to lenders. So, lenders are within their rights to restrict your LVR. While some lenders will allow you to loan up to 90-95% of the property’s value, others will cap the amount at 80%.
Going just $1 over the 80% threshold can easily cost you thousands of dollars in lender’s mortgage insurance. The good news is, you can reduce your LVR by saving up a larger deposit for the property you want to purchase – therefore reducing the amount you need to borrow.
Your loan to value ratio isn’t the only metric used by lenders to determine your borrowing power. When applying for a loan, your debt to income ratio is one of the primary factors used to determine your risk.
It refers to the percentage of your gross monthly income that goes to paying your monthly debt payments. To calculate your debt to income ratio, add up all your monthly debt obligations (for example, credit card repayments or other loans), then divide them by your gross monthly income (how much you earn before tax and other deductions).
Lenders also use the loan to value ratio to calculate how much cash you can pull out on a refinance. As the property value of your home may have changed since you bought the property, they will carry out an independent bank valuation. Most lenders will allow you to borrow up to 80% of the value of the property, minus the debt that you have left to pay.
Another similar option is a home equity loan. Home equity loans and cash-out refinances are alike, in that they allow you to access the equity you have accumulated in your home. But while a cash-out refinance replaces your current loan with a new term, home equity loan is an additional payment to make.
Home equity is the difference between what your home is worth and the amount you owe on your mortgage. A home equity loan allows you to access funds by borrowing against this balance through a lender.
Given most banks will likely lend you no more than 80% of your home’s current value, here’s how to calculate your home’s usable equity:
Let’s say your home is worth $500,000 on today’s market and you still owe $200,000 on your mortgage.
So, if your home is worth $500,000 and you still owe $200,000 on your mortgage, you have $200,000 of useable equity towards the purchase of an investment property.
Yes, just like any type of credit, you must pay back a home equity loan within the timeframe laid out in your terms. Failure to do so can result in legal action or in a lender taking your property as payment. However, you generally have a much longer time to pay back a home equity loan, as well as more flexible terms around repayment.
Need help securing a loan to purchase your dream property? Our experienced brokers have access to hundreds of competitive home loan deals, so we can help you find the right lender for you.