What is LVR?
A loan to value ratio is the size of your home loan, expressed as a percentage of the value of the property it was used to buy.
Calculated by dividing the amount of your current loan (or the amount you need to borrow) by your home’s lender-assessed value, it’s an important figure to keep in mind, as it directly relates to your ability to secure a loan.
How do you calculate your loan to value ratio?
Your lender uses two figures to calculate your loan to value ratio: their value of the property (which can sometimes differ from the purchase price) and the amount of money that you either already have borrowed or need to borrow.
So, let’s say your property is worth $400,000, and that you have saved a $80,000 (20%) deposit. This would mean that you need to borrow $320,000.
Your loan to value ratio would therefore be: $320,000 ÷ $400,000 = 80%.
It’s important to note, however, that the above scenario ignores the hidden costs of buying a home. Unless you have extra funds to cover stamp duty, legal fees and building inspections, you will need to dip into that $80,000, which will mean borrowing more money and increasing your loan-to-value ratio.
What is a high LVR?
Banks will often lend to borrowers with loan to value ratios (LVRs) of up to 95%, but those with a LVR of 80% or higher are deemed high risk. This is because a borrower with a high LVR is more likely to default on their loan than a borrower with a low LVR, as their monthly repayments will be higher.
Consequently, banks who lend to borrowers with LVRs of 80% or higher take out what’s known as lenders mortgage insurance, or LMI. Doing so allows them to make a claim in the event that the borrower defaults on their loan and the recovered property sells for less than the value of the mortgage, with the bank recovering any shortfall from their LMI provider.
But while the bank takes out the insurance, the borrower pays the bill. It’s technically made as a one-off payment at settlement, but banks generally offer to capitalise the fee into the borrower’s mortgage, so that it’s added to their monthly repayments. This saves them from a hefty upfront bill but costs them more in interest repayments.
Here are a few things to think about if you have a higher LVR.
Guarantor home loans: The simplest ways to reduce your LVR and avoid paying LMI are to save a larger deposit and look for a more affordable property. But if neither of those options are on the table, then a guarantor loan might be right for you. A guarantor loan is a home loan that uses equity in a guarantor’s property as security. Typically a friend or family member, the guarantor takes on the risk of the loan and essentially puts down a deposit for you, which reduces your LMI. The bank still lets you borrow and repay the money. But if you default on your loan, the lender will recover the debt from the equity your guarantor provided. Guarantor loans are a great way of getting onto the property ladder much sooner, but the risk taken on by the guarantor couldn’t be much higher, so it’s important to consider whether your relationship with them is strong enough to handle the stress.
Low deposit home loans Most lenders offer loans to borrowers with as little as a 5% deposit, but you should think twice about accepting one, as your monthly repayments will be a lot higher than those with larger deposits. That’s partly because you’ll be borrowing more money, and partly because the banks will charge you LMI to protect themselves in the event that you default on the loan. (Some will charge a ‘low deposit premium’ instead’). That said, it’s often worth getting a low-deposit loan and paying LMI when house prices are rising rapidly, as the amount you pay in LMI could end up being less than the amount the property increases in value during the time it takes to save a larger deposit. Whatever decision you make, just remember to give yourself enough wriggle room in your budget to deal with potential interest rate hikes of 2-3%.
Long term mortgages Finding a lender that offers you a long-term mortgage (one that stretches for 30 years or longer) will reduce your monthly repayments, but it will also significantly increase your total repayments over the length of the mortgage. For example, if you borrowed $400,000 on a 40-year mortgage, you would pay $193,000 extra in interest than you would with the same loan on a 30-year term (based on a 6% rate).
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The above information has been sourced from Realestate.com.au. To read the full article CLICK HERE.