The bank valuation
Let’s say you’ve bought your first home and now want to finalise your loan. Before the lender offers you unconditional approval they may send an independent professional to value the property.
Lenders do this because they use your property as security for the loan. In other words, if you default on your loan, the lender has the right to sell the property to recover the outstanding loan amount.
Sometimes the valuer may estimate the market value of the property is lower than the purchase price. Let’s look more closely at some scenarios where this may happen.
If you’re buying an off-the-plan apartment, it’s a good idea to remember that the lender is only able to value the finished property. Completion may be well over a year after you sign the contract and place a deposit.
There is a risk that property values in the area may change over the construction period. If they do, the bank valuation may be lower than your purchase price.
There is also a risk that the dimensions of the finished apartment may vary from the plans. This situation may result in a bank valuation that’s less than the purchase price.
Buying unregistered land
A similar situation may occur in new estates when developers offer unregistered land for sale. It may take several years for the developer to build the infrastructure necessary to register the land.
In this case, the lender will need to reassess your application before settlement. Over the time since you paid your deposit, values in the area may have changed, resulting in a valuation lower than your purchase price.
If you’d like to know more about what to consider when buying land, we have an article that looks at this subject in more detail.
What if the lender’s valuation is lower than the purchase price?
As we mentioned earlier, the lender values your property to see whether it provides enough security against the loan amount. To help assess their risk, lenders use a measure called the loan-to-value ratio (LVR).
Many lenders will not lend if the LVR is more than 95%. And if the LVR is more than 80% they will ask you to pay Lenders Mortgage Insurance (LMI).
Here are some examples of what could happen if a lender’s valuation affects your LVR:
The LVR is still below 80%
- Your purchase price is $500,000.
- You need to borrow $300,000.
- The lender’s valuation is $450,000.
- LVR is 300,000 / 450,000 = 67%.
In this case the loan application would still go ahead and you wouldn’t have to pay LMI.
The LVR is over 80%
- Your purchase price is $600,000.
- You need to borrow $420,000.
- The lender’s valuation is $500,000.
- LVR is 420,000/500,000 = 84%.
The loan may still go ahead but you will have to pay LMI. You could add the LMI cost to your loan if you have the income to service the larger loan amount.
To sum up
- The purchase price and the bank valuation might be different.
- The bank valuation is used to calculate your LVR.