If you’re in the process of finding a home loan to help you buy property, then it’s likely you will have encountered the term ‘loan to value ratio’ or ‘LVR’.
Despite the confusing language found in some areas of discussion surrounding home loans, most of these concepts are actually relatively straightforward and easy to understand.
Here we will break down what LVR means, and provide an overview of the implications that an LVR has on your home loan.
LVR is the three-letter abbreviation for the term ‘loan to value ratio’. This term is used to describe the percentage of the purchasing cost of a property that is being paid for with a loan versus the percentage of the cost which is being paid for in a cash deposit.
For example- James and June plan to buy a house worth $600,000.The fees associated with the purchase of this property (for the sake of our example) will be another $20,000.
This gives us a total purchase cost of $620,000.
Because they can afford to pay a $60,000 deposit towards the total purchase cost, they must take out a home loan of $560,000 in order to complete their purchase.
By dividing the home loan amount by the total purchase price, and expressing this as a percentage, it is possible to work out the LVR on this loan, which looks like:
$560,000 divided by $620,000 = 0.903
0.903 expressed as a percentage is 90.3%, meaning that James and June’s LVR on their loan will be 90.3%, or in other words, they will be borrowing 90.3% of the cost of purchasing their property.
Your LVR will have several implications on your home loan outcomes, and these can vary depending on your specific situation, the lender you will opt for, and other factors, but as a general rule the main implications to consider are:
The majority of lenders require the borrower to pay extra fees to cover the expense of lenders’ mortgage insurance, which is insurance taken out in order to cover the lender in the unlikely scenario that the borrower defaults on future loan repayments.
The higher your LVR is, the more you will need to pay towards LMI, as a greater portion of your property’s total cost will be outstanding. Most lenders require the borrower to pay for LMI for all loans with an LVR of over 80%.
Because a lower LVR means that you are likely to enjoy lower interest rates, a low LVR means that you will need to pay a larger deposit in order to save money in the long-run.
If we revisit James and June’s $620,000 property purchase, we can see this change in interest rates play out across different LVR scenarios.
Assuming the 90.3% LVR that we calculated above results in a 3% interest rate on a 25-year loan, monthly interest payments on this loan would begin at $1,400, with the sum of interest payments reaching $236,676.
If we apply an 80% LVR to the same loan resulting in a 2.5% interest rate, monthly interest payments would be at $1,041, with total interest payments over the term of the loan reaching only $172,926- a difference of over $63,000.