You'll come across a lot of confusing terms when you're buying property.
But one term you don't want to skip over is the loan-to-value ratio (LVR).
Not only will it help you figure out whether you're likely to get approved for a home loan. It can even affect how much you'll be paying for your property!
What is the loan-to-value ratio (LVR)?
LVR is the size of your home loan, as a percentage of the property's value.
How do you calculate your loan-to-value ratio (LVR)?
The calculation is pretty simple. You take your loan amount and divide it by the lender's valuation of the property. Then, multiply it by 100.
So if you're looking at buying a property worth $800,000 and you need a $600,000 loan, your LVR would be 80%. In other words, you have 20% equity in your property.
If you're still having trouble determining your LVR, here's our LVR calculator.
Why is the loan-to-value ratio (LVR) important?
Here are the top reasons why knowing your LVR is crucial:
- Lenders use the LVR to assess how risky a loan is. A higher LVR means higher risk for the lender.
- To bring this risk down, the borrower has to purchase lenders mortgage insurance (LMI). You may have to pay LMI even if you refinance at a later date with an LVR above 80%.
- Conversely, a low LVR signals less risk to the lender and increases your borrowing power.
- On top of getting the borrower to pay LMI, the lender may want to further reduce risk by charging higher interest rates and repayment amounts.
- It helps with estimating what property prices you can afford. Now that you understand what the LVR is, you can use it to gauge what property purchase price you can afford and how much money you'll need tstampo put down in order to get a loan without paying LMI.
Why is 80% LVR important?
80% LVR is kind of a magic number. At 80% LVR, most lenders operate on the basis that you've built up enough of a deposit to make your loan low-risk.
Simply put, home loan applications with an LVR above 80% are considered high-risk and are more likely to be declined. This is because there’s an increased risk that a lender may not recoup the full loan amount if the borrower defaults on the loan.
So, if you’re over 80% LVR That's why if you're over the 80% LVR, they need to reduce this risk by getting the borrower to pay lenders mortgage insurance (LMI).
This insurance allows the lender to make a claim if the borrower can't pay back the loan.
LMI is often charged on loans that are above 80% LVR, even if you’re refinancing and it can cost tens of thousands of dollars, depending on your home’s purchase price, your deposit size and your LVR.
How is the value of the property determined for LVR?
Lenders will usually use a bank valuation to determine the value of your property for calculating LVR. Bank valuations are conducted by professional valuers.
The final figure might be different from what you get from the estimated market value that real estate agents provide. The bank valuation gives the lender an idea of how much they'd be able to get back from selling the property if the borrower doesn't pay back the loan.
What are the other costs of home buying to be aware of?
If you're considering going ahead with a deposit below 20% and paying LMI, remember there are other upfront costs to consider before you sign on the dotted line:
- Stamp duty
- Conveyancing and legal fees
- Registration fees
- Building and pest inspection
- Application fees
- Council and water rates
Are there low-deposit home loan options without LMI?
Depending on your financial situation, you may be eligible for other low-deposit home loan options.
- Guarantor Loan
A guarantor home loan is a type of mortgage that allows someone else (usually a closely-related family member) to offer their savings or home equity as security on your home loan.
For example, if you can only come up with a 5% deposit, your guarantor might guarantee the remaining 15% to make up a 20% deposit.
You're more likely to get your application approved and you won't have to pay LMI.
However, it is important to note that the guarantor may lose whatever home equity they've pledged if the borrower defaults on the loan.
- Government schemes
The Australian government has several schemes available to first-home buyers to help increase borrowing power.
Some of the key ones for first-home buyers include:
- First Home Guarantee (aka First Home Loan Deposit Scheme) — In this scheme, the government guarantees part of your house deposit.
- First Home Owner Grant (FHOG) — The government provides grants to first home buyers ranging from $10,000-$30,000. The amount varies by state, although it is a national initiative.
Learn more about government schemes for first home buyers.
Main takeaway: aim for an LVR of 80% or less. But it's not a deal breaker
So if you want to get the best deal on your home loan, 80% or less is a good LVR to aim for. You'll avoid LMI and likely pay lower interest rates.
If you want a lower LVR, you can either save a larger deposit or look at properties that are cheaper than what you originally had in mind.
But if neither of these is an option for you, don't give up just yet! Speak to us at OwnHome if you want to explore deposit boost loans.