Securing a home loan involves several key factors, one of the most important being the Loan-to-Value Ratio (LVR).
This LVR percentage plays a crucial role in determining borrowing power, interest rates, and whether Lenders Mortgage Insurance (LMI) will be required.
A clear understanding of LVR helps borrowers make informed financial decisions and potentially save thousands over the course of their loan.
What Is Loan-to-Value Ratio (LVR)?
LVR is a measure used by lenders to assess the level of risk associated with a home loan. It represents the proportion of the loan amount compared to the total value of the property being used as security.
The calculation is straightforward: divide the loan amount by the property value and multiply by 100. For instance, if a borrower seeks a $400,000 loan for a property valued at $500,000, the LVR would be 80%.
How Does LVR Affect You?
LVR is a significant factor in home loan applications, as it directly influences a lender’s risk assessment. A lower LVR increases the likelihood of loan approval, qualifies borrowers for more competitive interest rates, and can help avoid Lenders Mortgage Insurance (LMI), which is typically required for loans exceeding 80% LVR.
When it comes to the lender's valuation of a property, or the purchase price (aka contract price), lenders generally use the lower of two figures to calculate LVR. If a property’s valuation is lower than the purchase price, the lender will base the LVR on the lower amount.
This is common in off-the-plan purchases, vacant land or transactions involving family members at a discounted price, also known as a favourable purchase. Some lenders may use the valuation instead of the purchase price, but this depends on factors such as the time elapsed between signing the contract and applying for the loan.
The Maximum LVR
LVR limits vary depending on a borrower’s financial profile and a lender’s policies. Borrowers who provide full income documentation can generally secure up to 80% LVR without LMI, and up to 95% LVR with LMI.
Self-employed borrowers with limited income documentation typically qualify for 60%-80% LVR. A 100% LVR loan is only possible with a guarantor, where a family member or friend offers part of their property’s equity as security.
In some cases, borrowers may access 100% LVR through paired lending, where commercial and residential loans are structured together.
Why Do Banks Restrict LVR?
Lenders may impose restrictions on LVR based on borrower risk or property type. If a borrower has a history of credit defaults, lenders may cap LVR at 90% or lower. Similarly, unique or high-risk properties, such as heritage-listed homes, serviced apartments, and rural properties, may be subject to lower maximum LVRs.
In economic downturns or high-risk locations, banks may also reduce LVR limits to safeguard against declining property values.
How to Lower Your LVR and Improve Your Borrowing Power
A lower LVR translates to reduced risk for lenders and can lead to better loan terms. Borrowers can lower their LVR by increasing their deposit, negotiating a more favourable purchase price, selecting properties with strong valuation potential, or waiting for property appreciation before applying for a loan. These approaches can enhance borrowing power and minimise additional costs such as LMI and/or a higher rate of interest.
Key Thoughts
Understanding LVR is crucial for making informed home loan decisions. A lower LVR can result in better loan terms, reduced interest rates, and potential savings on LMI.
Before applying for a mortgage, consult with our forward thinking Mortgage Brokers to help you optimize your borrowing power and loan options.
Our team is ready to guide you through LVR requirements and structure the best loan solution bespoke to your personal needs.