Alan Hartstein
Athena Cocoves
For first-time home buyers or those looking to buy an investment property, there is always plenty to think about before taking the plunge, especially when considering the size of the financial commitment you’re taking on.
One of these considerations is your loan-to-value ratio, or LVR, which will directly impact the amount of money you can borrow from your bank or financial institution.
What is LVR?
Put simply, your LVR is the percentage of the value of the property, as appraised by the bank, that you will need to borrow to purchase the property after putting down an initial deposit.
Let’s say you’ve found your ideal house or apartment and the bank values the property at $500,000. You’ve managed to save a deposit of $100,000, or 20% of the property’s value. To complete the purchase, you’ll need to borrow the other $400,000, or 80% of the property’s value, giving you an LVR of 80%.
The importance and meaning of LVR
LVR is important because it helps your financial institution to determine the level of risk associated with the home loan and will be one of the major determining factors in how much they decide to lend you. It’s important to note that the value estimated for the LVR is solely that of the bank and not the market value, meaning the bank’s valuation may not coincide exactly with the sale price.
How to calculate LVR
Let’s say, for example, that the above property, which is valued at $500,000 by the bank, is on the market for $550,000 and you’ll need to borrow $450,000 as opposed to only $400,000. Because the bank’s valuation for the property is at $50,000 less, your LVR is now 90% because you’ll need to borrow 90% of the amount that the bank has valued ($450,000 of $500,000).
If, conversely, the bank has valued the property at $550,000 and you can purchase it for only $500,000, you will only have to borrow 72.73% of the value of the property ($400,000), giving you an LVR of 72.73%.
How LVR affects a home loan
The bank’s valuation will depend on a range of factors, including location, previous sales in the area and proximity to amenities, such as schools, shopping centres and public transport. These are, of course, the same factors that affect the market valuation and the vendor’s desired sale price in the first place.
In reality, the bank’s valuation should more or less reflect market valuation most of the time. If. for some reason, your financial institution feels that the property is grossly overpriced, they probably won’t approve the loan in the first place.
This is especially true with auctions, where the more acute discrepancies between valuations and market prices may occur, especially in boom times in high-growth locations. As a first home buyer especially, it is imperative, and usually, a prerequisite, that you get conditional pre-approval from a lender before you attend an auction so you know exactly how much you are allowed to bid and you don’t get caught up in the excitement of the moment and exceed your maximum.
What is a good LVR?
A good LVR is the lowest LVR you can afford. Whatever your circumstances, having as low an LVR as possible is always a good thing. You should examine all the ways in which you can lower yours before applying for a home loan.
As a major determinant of how much you can borrow, the bank will always look favourably on a higher initial deposit, especially if you can provide evidence of having saved the money, as opposed to receiving a gift or loan from a generous relative or friend.
Why lower LVRs are highly beneficial
Having as low an LVR as possible is advantageous for a number of reasons.
Reduces your interest repayments
Buying a property is a major financial commitment that usually involves repayments spanning 20 or 30 years, so the lower the percentage of the value you’ll need to pay back over that period, the better. Using a loan calculator, such as the one provided by Moneysmart, will be the reality check you need to encourage you to save a bigger initial deposit.
Let’s say, for example, that with a property valued at $500,000, you’ve put down a 10% deposit and taken out a loan for 90% of the property’s LVR ($450,000) over 20 years at 5.6% interest, repaid monthly. In this scenario, your total repayment will be $749,032, of which $299,032 will be interest.
If, on the other hand, you have managed to save a 20% deposit ($100,000), and you only need to borrow $400,000 or an 80% LVR, your total repayment over the same period will be $665,806, of which $265,806 is interest, saving you nearly $35,000 in interest repayments.
Increases your future borrowing power
For those refinancing to buy a second property, the LVR on your existing property will also play a big part in how much you can borrow. Let’s say you bought the above property for $500,000 with a 20% deposit five years ago and you’ve paid another $50,000 off the principal, meaning you only owe $350,000. However, the property’s value has grown to $700,000, meaning your equity in the property (the amount you own minus the debt) has grown to 50%, giving you an LVR of only 50%.
Additionally, while the above figures are constructed using a set interest rate over a long period of time, in reality, this figure is constantly fluctuating and rampant inflation can have a deleterious effect on interest rates, as we are experiencing in the mid-2022s. For those that remember, home loan interest rates in Australia nearly hit a staggering 20% in the 1980s and did not go down to anywhere near where they are now for years afterwards, so the less you need to borrow in the first place obviously the better.
» MORE: How to increase your borrowing capacity
More freedom for first-time buyers
Having a lower LVR can also mean that, as a first-home buyer, you don’t need a guarantor for the loan. Often a condition of a bank loan may involve a parent or someone else guaranteeing the loan against assets, such as their own property. In the worst-case scenario, they may have to sell up to guarantee the loan if you’re unable to meet mortgage repayments.
Alternatively, if you don’t have a guarantor, a lower LVR may mean you don’t have to pay lenders mortgage insurance, or LMI, which is an amount payable at the outset as a loan prerequisite to protect the bank, but is effectively money down the drain.
You could get a better interest rate
Finally, your lender may offer you a more attractive initial interest rate for the first few years of the loan, or a fixed lower interest rate for far longer (possibly five years or more) than you would otherwise get if your LVR is higher.
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