How does LVR work?

How does LVR work?
The term LVR is frequently mentioned when looking for a home loan, but what does it actually mean?
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The term LVR is frequently mentioned when looking for a low interest home loan, but what does it actually mean?

We’re here to help you understand what it is, how it's calculated and why it’s so important.

What is LVR?

The loan-to-value ratio, or LVR, is the value of a property compared to the amount of money you wish to borrow in a home loan, shown as a percentage. LVR is essentially how lenders can assess the risk factor of a loan. The higher the LVR percentage, the higher the risk the loan represents to the lender and vice versa.

For example, a borrower with an LVR of 60% would be considered as low risk, while an LVR of 95% would be considered high risk. It’s important to note lenders use the property’s valuation for LVR, not the price it’s selling for.

How is LVR calculated?

Unlike many formulas in finance, the formula for calculating LVR is relatively straightforward. Lenders will typically divide the loan amount by the property's value and convey it as a percentage value, which is your LVR.

For example, if you want to buy a $500,000 property and have a $50,000 deposit, you would need to borrow $450,000. Dividing $450,000 (the loan amount) by $500,000 (the valuation of the property) comes to 0.9. Multiply this figure by 100 to calculate your percentage value, which gives you an LVR of 90%.

The table below shows further examples of LVR:

Property value Deposit Loan amount LVR
$500,000 $50,000 $450,000 90%
$500,000 $75,000 $425,000 85%
$500,000 $100,000 $400,000 98%
$500,000 $150,000 $350,000 70%

Why does LVR matter?

LVR is incredibly important because it can affect both the interest rate a lender will offer and how much they will let you borrow. It’s generally advised the lower your LVR can be the better, because many lenders will offer loans with heavily discounted rates with lower LVRs.

For example, our Smart Home Loan has a discounted rate of 2.63% p.a. (2.65% p.a. comparison rate) and is available for borrowers with an LVR of up to 80%.

This is because borrowers with an LVR of 80% or less are considered low risk. A low LVR means the property should be worth a lot more than the amount which has been borrowed, so in the event the borrower does default, the lender can easily recover the debt by repossessing the home and selling it.

Your LVR can also determine how much you’ll be able to borrow and the size of the deposit you will need for a home loan.

For example, if a loan has a maximum LVR of 80% and the value of the property you wish to purchase is $500,000, the lender won’t let you borrow more than $400,000 and you would need a $100,000 deposit. This is another way in which the lender protects itself from borrowers deemed higher risk.

What LVR should you aim for?

It’s typically advised you aim for an LVR of 80% or less. This isn’t just because many lenders offer better rates to borrowers with this LVR but also because you’ll avoid Lenders Mortgage Insurance (LMI). Borrowers who have an LVR greater than 80% are required to pay Lender's Mortgage Insurance (LMI). It acts as a safety net to lenders who are taking on borrowers who are considered higher risk.

LMI varies between lenders and your LVR but it can rack up into the thousands. LMI issuer Genworth, estimates an owner-occupier looking to borrow $450,000 over 30 years with an LVR of 90%, would pay around $9,644.

Although not practical for some borrowers, it’s often better to save a 20% deposit before looking to buy a home.

The benefits of having 80% LVR

Even though you don’t need a huge deposit to take out a home loan, having a larger deposit has many advantages.

This is especially true if you can get to 20 per cent or more, which is the magic number where a number of costs are reduced or disappear completely.

With a 20 per deposit, also known as 80 per cent LVR (Loan to Value Ratio), you will get the following specific benefits.

  • No Lenders Mortgage Insurance – LMI protects the lender against the risk that you will default. If you have to borrow more than 80 per cent of the purchase price, you will have to get LMI which typically costs around 2% of the value of the loan. On a $500,000 loan, that is $10,000. If you have a deposit of 20 per cent or more, you can save this entire cost.
  • Lower interest rate – most lenders, including loans.com.au, offer a lower interest rate to borrowers who have an LVR of 80 per cent or less. This is because with more equity in the home, there is less risk that they will lose money if you default. This reduced interest rate can add up to tens of thousands of dollars over the life of the loan.

As well as these specific benefits for having a deposit over 20 per cent, there are a number of general benefits from having a larger deposit that will increase the bigger the deposit gets.

  • Borrow less – it is obvious, but the bigger your deposit, the less you will have to borrow to buy your home. For example, if you can save a 30 per cent deposit, that is 30 per cent of the home’s value that you won’t be paying interest on.
  • More borrowing power  the more money you have saved, the less risk you represent as a borrower. If a lender is confident you’ll be able to comfortably service your loan, you may be able to borrow more.
  • Proof of savings  when you apply for a loan, you will need to show evidence of a regular savings history. If you have managed to save a 20 per cent deposit or more, you will probably have excellent proof of savings.

Whether it comes from saving your income, or from accumulating equity in another property, there are big benefits to having an LVR of 80 per cent or less when you go to take out a home loan. It will save you money, make it easier to get approval for a loan, and give you access to a wider range of of home loan options.

If you’re beginning your home loan journey and have an idea of what your LVR may be, calculate your borrowing power.

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