High LVR Loans: Risks and Alternatives
For many Australians, the dream of homeownership can seem out of reach due to the challenge of saving a substantial deposit. This often leads potential buyers to consider high Loan-to-Value Ratio (LVR) loans. While these loans can provide a pathway to property ownership, they come with significant risks and costs. This article will explore the downsides of high LVR loans and present alternatives that may be more financially prudent for aspiring homeowners.
Understanding LVR and High LVR Loans
Loan-to-Value Ratio (LVR) is a key metric used by lenders to assess the risk of a home loan. It’s calculated by dividing the loan amount by the lender’s valuation of the property and expressing it as a percentage. For example, if you’re borrowing $400,000 for a property valued at $500,000, your LVR would be 80%.
Generally, an LVR of 80% or less is considered ideal by lenders. Loans with an LVR above 80% are classified as high LVR loans and are viewed as higher risk.
Risks and Downsides of High LVR Loans
While high LVR loans can help you enter the property market sooner, they come with several significant drawbacks:
1. Lender’s Mortgage Insurance (LMI) or Low Deposit Premium (LDP)
For loans with an LVR above 80%, lenders typically require borrowers to pay for Lender’s Mortgage Insurance (LMI) or a Low Deposit Premium (LDP). These are one-off, non-refundable insurance premiums that protect the lender if you default on your loan. LMI can add thousands of dollars to your loan, increasing your overall debt and monthly repayments.
2. Higher Interest Rates
Many lenders charge higher interest rates for high LVR loans to offset the increased risk. This means you’ll pay more in interest over the life of your loan, potentially costing you tens of thousands of dollars extra.
3. Limited Loan Features
High LVR loans often come with fewer features and less flexibility. You may miss out on beneficial options like offset accounts, redraw facilities, or the ability to make extra repayments, which can help you save on interest and pay off your loan faster.
4. Increased Vulnerability to Market Fluctuations
With a smaller equity buffer, you’re more vulnerable to negative equity if property values decline. This can make it difficult to refinance or sell the property if needed.
5. Stricter Lending Criteria
Lenders often apply more stringent assessment criteria for high LVR loans. This can include higher credit score requirements, stricter income assessments, and more detailed scrutiny of your expenses and financial history.
Alternatives to High LVR Loans
Given the risks associated with high LVR loans, it’s worth exploring alternatives that can help you achieve homeownership with less financial strain:
1. First Home Loan Deposit Scheme (FHLDS)
The Australian Government’s First Home Loan Deposit Scheme allows eligible first home buyers to purchase a property with as little as a 5% deposit, without paying LMI. The government guarantees up to 15% of the property value, effectively bringing the LVR down to 80% from the lender’s perspective.
2. First Home Super Saver Scheme (FHSSS)
This scheme allows first home buyers to save for a deposit within their superannuation fund, taking advantage of the concessional tax treatment of super to boost their savings.
3. State-based First Home Owner Grants
Many Australian states and territories offer grants to first home buyers, which can help boost your deposit and reduce your LVR.
4. Family Guarantee or Family Pledge Loans
Some lenders offer products that allow family members (usually parents) to use the equity in their own property as security for a portion of your loan. This can help you avoid LMI and potentially secure a lower interest rate.
5. Shared Equity Schemes
Several states have introduced shared equity schemes where the government co-purchases a portion of the property with you, reducing the amount you need to borrow and lowering your LVR.
6. Rent-to-Buy Schemes
While less common in Australia, some developers offer rent-to-buy schemes where a portion of your rent goes towards building equity in the property.
7. Save a Larger Deposit
While it may delay your entry into the property market, saving a larger deposit can significantly reduce your LVR, helping you avoid LMI and potentially secure better loan terms.
Strategies for Managing High LVR Loans
If you do decide to proceed with a high LVR loan, consider these strategies to mitigate the risks:
- Make extra repayments: As soon as you can, start making additional repayments to build equity faster and reduce your LVR.
- Refinance when possible: Once your LVR drops below 80%, consider refinancing to potentially secure a better interest rate and more favourable terms.
- Value-add renovations: If feasible, consider making improvements to your property that could increase its value, effectively lowering your LVR.
- Income-boosting strategies: Look for ways to increase your income, such as taking on additional work or starting a side hustle, to help you make extra repayments.
While high LVR loans can provide a path to homeownership for those struggling to save a large deposit, they come with significant risks and additional costs. Before committing to a high LVR loan, it’s crucial to carefully consider the long-term financial implications and explore all available alternatives.
Government schemes, family assistance, and alternative lending products can offer ways to enter the property market without the drawbacks of a high LVR loan. Additionally, strategies like saving for a larger deposit or looking at more affordable properties can help you achieve a lower LVR and a more stable financial footing.
Ultimately, the right choice depends on your individual circumstances, financial goals, and risk tolerance. It’s always advisable to seek professional financial advice to help you navigate the complexities of home loans and find the best solution for your situation. With careful planning and consideration of all options, you can work towards homeownership in a way that aligns with your long-term financial wellbeing.