If you’re in the market for a home loan, you’ll probably have heard the term loan-to-value ratio, or LVR. So what exactly is it?

Buying a home in Australia is a significant financial decision, and understanding the jargon floating around is crucial. One frequently encountered term is LVR, which stands for Loan-to-Value Ratio.

What is Loan to Value Ratio?

Simply put, LVR is the percentage of the property value you borrow for your home loan. It reflects the proportion of your deposit compared to the loan amount needed.

How to Calculate LVR

Calculating your LVR is straightforward:

• Loan amount: This is the amount you're borrowing from the lender to purchase the property.

• Property value: This is the estimated market value of the property you're interested in buying. You can obtain this through a formal valuation or use online estimates as a starting point.

1. Do the math: Divide your loan amount by the property value. For example, if your loan amount is $400,000 and the property value is $500,000, the equation would be:

$400,000 (loan amount) / $500,000 (property value) = 0.8

2. Express it as a percentage:

Multiply the result by 100 to express your LVR as a percentage. In this example:

0.8 x 100 - 80%

So, your LVR for this scenario would be 80%.

What is a Good LVR?

Generally, a lower LVR is considered better for both you and the lender. Here's a breakdown:

• LVR below 80%: This is deemed ideal, often leading to lower interest rates and potentially avoiding Lenders Mortgage Insurance (LMI).

• LVR between 80% and 95%: Lenders might still offer competitive rates, but LMI typically applies, adding to your loan costs.

• LVR above 95%: Such high LVRs are rare and usually require special loan products with potentially higher interest rates and mandatory LMI.

How Does LVR Affect Your Interest Rate?

Your LVR plays a significant role in determining the interest rate you'll be offered on your home loan. Think of it as a gauge of risk for the lender: the higher your LVR, the more money you're borrowing compared to your own contribution, raising their concerns about potential losses if you default. Here's how LVR influences your interest rate:

Lower LVR, Lower Rates:

• Reduced Risk: A lower LVR signifies less risk for the lender, as the property value serves as a larger buffer against potential losses in case of default. This incentivises them to offer you a lower interest rate, potentially saving you thousands of dollars over the loan term.

• Attractive Deals: Lenders often have tiered interest rates based on LVR ranges. The lower your LVR falls within a tier, the better the rate you'll qualify for.

Higher LVR, Higher Rates:

• Increased Risk: Conversely, a higher LVR presents greater risk for the lender. To compensate for this increased risk, they'll charge you a higher interest rate. This can significantly impact your monthly repayments and overall loan cost.

• Limited Options: Higher LVRs might restrict access to some of the most competitive loan products with the lowest interest rates.

The Sweet Spot:

Generally, an LVR below 80% is considered the golden zone for securing the most competitive interest rates. This is because most lenders won’t charge Lenders Mortgage Insurance (LMI) on loans with an LVR of 80% or less. This insurance protects the lender if you default, but comes at an additional cost. Aiming for a below-80% LVR eliminates the need for LMI, saving you money both upfront and through lower monthly repayments.

How Can LVR Affect Your LMI Cost?

LMI acts as a safety net for lenders in case you default on your home loan. Generally, LMI applies when your LVR exceeds 80%. The LMI cost is calculated based on your loan amount, LVR, and other factors. A higher LVR translates to a higher LMI cost, further increasing your overall loan expenses.

The exact LMI cost depends on a few factors:

• Loan amount: The larger the loan, the higher the LMI premium.

• LVR: As mentioned above, a higher LVR translates to a proportionally higher LMI cost. Some lenders might have tiered pricing based on specific LVR ranges.

• Property type: Investment properties typically incur higher LMI premiums than owner-occupied ones.

• Lender and LMI provider: Different lenders and LMI providers may have varying pricing structures.

How Can You Reduce Your LVR?

To achieve a lower LVR and potentially enjoy better loan terms, consider:

• Increasing your deposit: Saving more upfront lowers your loan amount, reducing your LVR. This might seem obvious, but diligently prioritising saving a larger deposit is the most direct way to lower your LVR. Analyse your budget, cut unnecessary expenses, and consider temporary side hustles to accelerate your savings goals. Reassess your finances and consider putting any existing savings accounts, inheritances, or bonuses towards your deposit.

• Exploring government first-home buyer schemes: Many Australian states and territories offer first-home buyer schemes that can significantly impact your LVR. Deposit grants provide financial assistance towards your deposit, effectively reducing your loan amount and lowering your LVR. Some government programs offer loan guarantees, allowing you to purchase a home with a lower deposit (lower LVR) without LMI.

• Purchasing a less expensive property: This strategy allows you to maintain a lower LVR even with your existing deposit. While your dream home might be in a pricey suburb, consider exploring more affordable areas where your existing deposit translates to a lower LVR. Apartments or smaller homes generally have lower price tags compared to detached houses, potentially allowing you to achieve a lower LVR with your current savings.

Are There Home Loans with 100% LVR?

In Australia, traditional lenders rarely offer 100% LVR loans due to the high risk involved. However, some government-backed schemes or niche lenders might offer options with very high LVRs, often with stricter eligibility criteria and potentially higher loan costs.

What are the Risks of High LVR Home Loans?

While a high LVR might seem enticing by allowing you to buy sooner, it comes with potential risks:

• Higher Interest Rates: You'll likely face higher interest rates, translating to significantly higher repayments over the loan term.

• LMI Costs: Mandatory LMI adds to your overall loan expenses, further increasing your financial burden.

• Greater Vulnerability to Market Fluctuations: With less equity in your property, you're more exposed to potential market value drops, making it harder to sell or refinance if needed.

Photo by Scott Graham on Unsplash