What is Loan-to-Value Ratio (LVR) and Why It Matters
The Loan-to-Value Ratio (LVR) is a crucial metric in the world of home loans, influencing both the borrowing capacity of potential homeowners and the risk assessment by lenders. Understanding LVR is essential for anyone looking to purchase property, as it impacts the size of the deposit required, the interest rates available, and the overall terms of the mortgage. This article explores what LVR is, how it is calculated, and why it matters in the local market.
Understanding Loan-to-Value Ratio (LVR)
LVR is a percentage that represents the size of a loan compared to the value of the property being purchased. It is calculated by dividing the loan amount by the lender-assessed value of the property and multiplying by 100. For example, if you are purchasing a property valued at $500,000 and have a deposit of $100,000, you would need a loan of $400,000. The LVR would be calculated as follows:
LVR} = (Loan Amount/Property Value) x 100 = (400,000/500,000) x 100 = 80%
This means you are borrowing 80% of the property’s value.
Why LVR Matters
- Risk Assessment by Lenders
LVR is a key factor in assessing the risk of a loan. A higher LVR indicates a higher risk for the lender, as it means the borrower has less equity in the property. Lenders typically prefer lower LVRs because they provide a buffer in case property values fall. As a result, loans with higher LVRs may come with higher interest rates or require additional security measures, such as Lenders Mortgage Insurance (LMI).
- Impact on Borrowing Power
The LVR can directly affect how much you can borrow. Most lenders consider an LVR of 80% or lower as ideal, as it suggests a lower risk. If your LVR exceeds 80%, you may face restrictions on the amount you can borrow or be required to pay LMI. This insurance protects the lender if you default on the loan, but it does not provide any benefit to you as the borrower.
- Influence on Interest Rates
A lower LVR can also lead to more favourable interest rates. Lenders often offer better rates to borrowers with lower LVRs because they represent a lower risk. This can result in significant savings over the life of the loan, making it advantageous to aim for a lower LVR when possible.
LVR Restrictions and Regulations
The Reserve Bank introduced LVR restrictions to manage financial stability and curb excessive borrowing in the housing market. These restrictions require borrowers to have a minimum deposit, which varies depending on whether the property is for owner-occupation or investment. Generally, owner-occupiers need a deposit of at least 20%, resulting in an LVR of 80%. Investors typically require a larger deposit, often around 30%, to achieve a maximum LVR of 70%.
Strategies to Improve Your LVR
- Increase Your Deposit
One of the most effective ways to lower your LVR is to increase your deposit. Saving more before purchasing a property can reduce the amount you need to borrow, thereby lowering your LVR. This can also help you avoid LMI and secure better interest rates.
- Choose a Less Expensive Property
Opting for a property with a lower purchase price can help reduce your LVR. By borrowing less, you can achieve a more favourable LVR, which may provide access to better loan terms and conditions.
- Make Extra Repayments
If you already have a mortgage, making additional repayments can help reduce the loan balance faster, improving your LVR over time. This strategy not only lowers your LVR but also reduces the total interest paid over the life of the loan.
- Refinance Your Loan
Refinancing your mortgage with a new lender who offers a better property valuation can improve your LVR. This is particularly useful if the property market has appreciated since you purchased your home.
The Loan-to-Value Ratio (LVR) is a critical component of the home loan process, influencing borrowing power, interest rates, and lender risk assessment. Understanding and managing your LVR can provide significant financial benefits, including lower interest rates and reduced insurance costs. By increasing your deposit, choosing a less expensive property, making extra repayments, or refinancing your loan, you can improve your LVR and enhance your financial position. Taking the time to understand LVR and its implications will help you make informed decisions when purchasing property and securing a mortgage.