Understanding LVR: What It Is and Why It Matters
When you’re looking to buy a property in Australia, one term you’ll frequently encounter is Loan to Value Ratio (LVR). Understanding LVR is crucial because it directly impacts your borrowing power, the interest rates you’ll be offered, and the overall cost of your mortgage. This comprehensive guide will explain what LVR is, how it’s calculated, and why it matters to both borrowers and lenders.
What is Loan to Value Ratio (LVR)?
Loan to Value Ratio (LVR) is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased. In the context of home loans, it represents the amount you need to borrow as a percentage of the property’s value.
How is LVR Calculated?
LVR is calculated by dividing the loan amount by the lender-assessed value of the property and then multiplying by 100 to get a percentage. Here’s a step-by-step example to illustrate:
- Lender-assessed value of the property: $500,000
- Your deposit: $100,000
- Loan amount needed: $400,000
The LVR calculation would be:
LVR = (Loan Amount/Lender-assessed Value) x 100 = (400,000/500,000) x 100 = 80%
Why LVR Matters
LVR is a critical factor for both borrowers and lenders for several reasons:
1. Borrowing Power
The LVR affects how much you can borrow. Generally, the lower the LVR, the more favourable the loan terms will be. A lower LVR indicates that you are borrowing less relative to the property’s value, which is less risky for the lender.
2. Interest Rates
Lenders often offer lower interest rates for loans with lower LVRs. This is because a lower LVR means less risk for the lender. For example, ANZ offers lower interest rates for loans where the LVR is 70% or less[1].
3. Lenders Mortgage Insurance (LMI)
If your LVR is above 80%, you will likely need to pay Lenders Mortgage Insurance (LMI). LMI protects the lender in case you default on your loan. While it doesn’t protect you as the borrower, it allows you to secure a loan with a smaller deposit. The cost of LMI can be significant, so aiming for an LVR of 80% or lower can save you money.
4. Loan Approval
Lenders use LVR to assess the risk of a loan application. A lower LVR is generally viewed more favourably and can increase your chances of loan approval. Lenders like NAB consider multiple factors, including LVR, when assessing loan applications.
Factors Influencing LVR
Several factors can influence your LVR:
- Deposit Size: A larger deposit reduces the loan amount, thereby lowering the LVR.
- Property Value: The lender’s valuation of the property can differ from the market value. Lenders typically use the lower of the purchase price or their valuation to calculate LVR.
- Additional Costs: Upfront costs such as stamp duty, legal fees, and other expenses are not included in the LVR calculation but can affect the amount you have available for a deposit.
Managing Your LVR
1. Save a Larger Deposit
One of the most effective ways to lower your LVR is to save a larger deposit. This reduces the loan amount you need and can help you avoid LMI.
2. Choose a Less Expensive Property
Opting for a less expensive property can help you achieve a lower LVR, as the loan amount required will be smaller relative to the property’s value.
3. Consider a Guarantor
Some lenders offer guarantor loans, where a family member uses their property as additional security. This can help you secure a loan with a lower LVR and avoid LMI.
Real-World Example
Let’s consider Kerry and Srikanth, who want to buy a property valued at $1,000,000. They have a deposit of $100,000, meaning they need to borrow $900,000. Their LVR would be:
LVR = (900,000/1,000,000) x 100 = 90%
With an LVR of 90%, they would likely need to pay LMI and might face higher interest rates. If they saved an additional $100,000, their LVR would drop to 80%, potentially saving them thousands in LMI and interest over the life of the loan.
Understanding LVR is crucial for anyone looking to buy property in Australia. It affects your borrowing power, interest rates, and the overall cost of your mortgage. By managing your LVR through saving a larger deposit, choosing a less expensive property, or considering a guarantor, you can secure more favourable loan terms and save money in the long run. Always consult with financial advisors and lenders to understand how your LVR impacts your specific situation and to explore the best options available to you.