A low or high loan to value ratio (LVR) is a big factor affecting a lender’s willingness to approve your home loan application, so understanding what they are is crucial.
Generally, a low LVR is more favourable, with lenders opting for an 80/20 sweet spot for their security.
But lenders do conditionally provide high LVR home loans of more than 80%, with the condition that the borrower is required to cover the lenders’ mortgage insurance (LMI).
If all this jargon is confusing to you, then read this guide to help you understand what LVR is and how it works, what’s considered high and low, and how and why these things matter when you’re applying for a home loan.
What Is a Loan To Value Ratio?
When you’re ready to buy a home, you are likely to have some money saved up towards a deposit. When you inquire with a lender, they will first evaluate the property.
So, the loan amount you need to borrow is the value of the property, less your deposit.
The loan to value ratio is how much money you need to borrow, divided by the value of the property.
Here’s an example:
Nicky’s lender has valued the property she would like to purchase at $500,000.
Over the past few years, Nicky has been waitressing and doing other odd jobs to raise money for her deposit, and she has reached her goal of $30,000.
Therefore, Nicky needs to borrow a loan amount of $470,000.
Her LVR will be calculated by dividing the amount she needs to borrow by the value of the property.
470,000 ÷ 500,000 = 94%
So, Nicky’s LVR is expressed as a percentage at 94%.
Why Do Lenders Consider LVR Before Approving a Home Loan?
Two main reasons why lenders pay attention to your loan to value ratio are to establish whether you need to pay LMI and work out the applicable interest rate.
Lenders Mortgage Insurance (LMI)
Lenders feel most comfortable when borrowers can pay a 20% deposit as this amount adequately protects the lender. This means the LVR sweet spot is 80/20.
A deposit of 20% is considered to be enough security to cover the collateral should the borrower default on payments, so if you meet the other lending criteria, there’s a good chance your loan will be approved.
A high LVR typically more than 80% may require the borrower to pay an additional fee of LMI on their loan as extra security for the lender.
Borrowers do have options to waive lenders mortgage insurance, such as having a guarantor on their home loan.
To entice borrowers to opt for a lower LVR, lenders may charge correspondingly higher interest rates on home loans with a loan to value ratio higher than 80%.
A borrower might be approved for a home loan with a high LVR, but they should consider that they could be paying extra for LMI and experience higher interest rates. Ultimately this would result in a higher amount of monies owed, but with the benefit of securing a loan sooner with a lower deposit.
Can I Be Approved for a Home Loan With a High LVR?
If you don’t have a deposit of 20% or more and the home loan amount you need to borrow is more than 80% of the value of your property, you can still be approved for a high LVR home loan.
Many people buying a home opt to save up a 20% deposit, so they don’t need to pay for LMI or a higher interest rate.
But for some prospective homeowners, saving a 20% deposit can take time. Therefore, some borrowers would instead become homeowners sooner and pay a smaller deposit, even though extra fees and charges apply when doing so.
The lending criteria to be approved for a home loan with a high loan to value ratio, lenders generally require:
- a good credit history,
- permanent Australian residency or citizenship,
- proof of consistent employment for a period of time,
- a high income compared to your home loan amount,
- proof of genuine savings of at least 5% of the home’s value, and
- low credit card and other debt.
Why Is a Low LVR Beneficial?
Aside from avoiding LMI and enjoying lower interest rates, taking out a home loan with a low value ratio increases your borrowing power. As a lower risk client, you will potentially be eligible for more or increased home loan products and services.
And, by paying a larger deposit, you can either pay off your home loan quicker, or have smaller monthly mortgage repayments.
Lastly, the lower your LVR, the higher the equity in your property will be – equity increases with the amount you have paid towards your home loan.
How Can the Mortgage Agency Help?
Our mortgage brokers have valuable experience working with both high and low LVR loans and can help you calculate your LVR accurately.
Then, they can assess your financial situation to calculate your borrowing power to establish whether your loan has a good chance of being approved or not.
When you’ve decided to apply, our mortgage brokers will help you gather all the important information for your application.
And, we’ll determine the other costs involved, such as stamp duty.
The clients’ best interest comes first, and our mortgage brokers will negotiate the lowest interest rate possible. We will consider all avenues to save you money, including possible ways to avoid paying LMI.
The loan to value ratio (LVR) is calculated by dividing the amount you need to borrow by the property’s market value.
An LVR above 80% is considered a high LVR associated with higher risk. As a result, lenders generally require borrowers to pay additional lenders mortgage insurance, and they charge higher interest rates on the loan.
A lower LVR of less than 80% has a larger deposit with less risk and protects the lender, meaning no LMI is required.
Depending on your property goals and your current financial situation, it’s important to remember that neither option is necessarily better than the other. You need to choose which option suits you and your circumstances best.
If you need guidance, contact The Mortgage Agency or request a call back, and we will gladly assist you.
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.