Mortgage borrowers need to understand the concept of loan-to-value ratio (LVR) to help them assess their borrowing power and to carefully plan their next move.
If you are applying for a home loan, you need to understand that the LVR is one of the most crucial factors lenders will look into when deciding whether to give you an approval.
What does the loan-to-value ratio refer to?
The LVR refers to the amount you are borrowing as a share of the overall value of your property. Lenders use LVR when assessing the risks they are exposing themselves to if they let you borrow.
This ratio is calculated by dividing the amount of the loan by the value of the property. The value will not be based on the advertised price of your target house — instead, banks conduct their own valuation of the property.
Here’s an example: if the lender-assessed value of your property is $550,000 and the amount of you intend to borrow is $460,000, your LVR is 80%.
($460,000 / $550,000) x 100 = 80% LVR
What do banks consider when conducting valuation?
As mentioned earlier, banks often use their own valuation of the property rather than the actual sale price. If you are planning to buy an off-the-plan unit, the lender-assessed value will be considered, given that there is a possibility of price movements after the contract is signed.
Lenders also use their own valuation in favourable purchases, or those sales that are below market value. In such cases, the banks will still use the market value of your property to calculate your LVR. If the actual value is higher than the price you are paying for, then you might be able to apply for a home loan without a deposit.
When you refinance your home loan, your lender will also conduct a revaluation, since your property's original value might no longer be the same in the current market.
How do the LVR impact your home loan?
The LVR determines your risk to the lender as a borrower. Banks usually impose an 80% LVR cap on mortgages. This means that you need to have at least 20% of your property's assessed value as a deposit.
If you intend to borrow more than 80% of the property's value, banks will require you to pay for lenders mortgage insurance (LMI). This insurance policy works as a blanket of security for the lender in case you find yourself unable to continue making repayments in the future due to financial difficulties. Try Your Mortgage's LMI Calculator to give you an idea how much you are going to pay over the course of the mortgage.
The rule of thumb is, the lower the LVR, the higher the chances of you getting approved and obtaining a competitive offer from your lender.
To lower your LVR, you need to make a larger down payment or look for a more affordable property in your ideal suburb.
Is 100% LVR loan possible?
A 100% LVR means that you are borrowing an amount of money that is equal to the entire value of your property. The only possible way to do this is to have a guarantor that will support your mortgage application.
It is imperative that guarantors are property owners. They must also have a significant equity on their property, which they will use to secure a portion of your home loan. Doing so will allow you to borrow with a 100% LVR.
Make sure that you understand the concept of the LVR before you apply for a loan. If you want further assistance, you can reach out to mortgage brokers.