Loan to Value Ratio (LVR) is how lenders describe the amount you need to borrow to buy a particular property. In a nutshell: it’s the amount you need to borrow, calculated as a percentage of the property’s 'lender-assessed value'.
The ‘lender-assessed value’ is basically your lender’s valuation of the property.
Let’s break it down a bit more. Here’s an example:
- Let’s say your lender values the property at $500,000.
- Let’s also say you have a $100,000 deposit.
- This means you need to borrow $400,000 to buy the property.
Your LVR would be calculated like this:
$400,000 ÷ $500,000 = 80%
In the above example, we’ve simplified things by leaving out some of the fees and costs you might have to pay – but more about those later.
So now you know how your LVR is calculated. So far, so good. But what does it mean when it comes to your borrowing power?
Generally, the lower the LVR, the better
Why is a low LVR considered better? From the lender’s perspective, a lower LVR generally carries less risk.
A lower LVR may also be good news because you’ll be off to a head start when it comes to owning your home. If your LVR is lower, you will have more equity in your home right from the start. (Equity is the market value of your property, minus the amount of your loan you still have to repay.)
What happens when your LVR is over 80%?
When it comes to LVR, 80% is widely considered the tipping point. As soon as your LVR tips over 80%, the cost of getting a home loan may start to increase. This is because borrowers with a LVR of over 80% may be required to pay for Lenders Mortgage Insurance (LMI).
LMI protects the lender if you default on your home loan and there’s a shortfall following the sale of the property. Even though you’ll be the one paying the insurance premium, LMI won't provide you with protection. It only protects the lender.
Generally speaking, the higher your LVR, the more LMI will cost.
You need to make sure you understand LMI before deciding if it’s a good idea for you. Everyone’s circumstances are different, so learn as much as you can and consider the alternatives.
Read our article on Lenders Mortgage Insurance to learn more about ‘LMI’, ‘shortfall’ and the possible consequences.
A word about fees and costs
There are a few upfront fees and costs you may have to pay when buying a house. If you haven’t taken these costs into account, you may end up having less money left for your deposit. The less you have for your deposit, the higher your LVR will be.
Read our article on the unexpected costs of buying a house to find out more.
To sum up
- Loan to Value Ratio (LVR) is calculated by dividing the loan amount by the lender-assessed value of the property.
- Generally speaking, most lenders consider a LVR of 80% or more as being risky.
- If the LVR is higher than 80%, you may need to pay for lenders mortgage insurance.