Loan To Value Ratio (LVR)

When discussing home loans and mortgages, you may often hear the term “loan to value ratio.” The loan to value ratio, or LVR, refers to the ratio of the loan amount to the value of the property. It is typically expressed as a percentage. 

This ratio is extremely important in all aspects of lending. The majority of banks and financial institutions have lending policies for each type of loan that are related to the loan to value ratio. For example, the bank may only allow up to an 80% loan to value ratio on investment loans, but may allow up to 95% LVR on loans used for a primary residence. 

In order to calculate the loan to value ratio, one must divide the principal loan amount by the value of the home. A $200,000 loan on a house with a value of $300,000 would have a loan to value ratio of approximately 67%. When a lender calculates the loan to value ratio for the purchase of a piece of property, they will either use the valuation amount or purchase price, depending on which is lower. The worst case scenario occurs when the purchase price is higher than the valuation, resulting in a higher loan to value ratio than was anticipated. High loan to value ratios mean higher mortgage insurance premiums. In addition, if there is a significant enough difference between the value of the home and the purchase price, the loan may be declined. 

When a loan to value ratio is calculated for a refinance, the valuation amount is always used. On rare occasions, a lender may use valuations even if they are higher than the purchase price for a home loan, but usually only if the sale contract is several months old. 

If possible, one should always obtain a valuation prior to submitting an application for a loan. This can save a lot of unnecessary trouble and inflated hopes in situations where the valuation amount will determine the borrower’s ability to secure the loan. Once the borrower has determined that he or she will meet the lender’s loan to value ratio requirements, the application can be submitted. 

Typically, a lender will require mortgage insurance for any loan with an LVR of more than 80%. However, for lo doc loans, this percentage may be as low as 60%. For first time buyers, the loan will usually have a relatively high loan to value ratio. In fact, in many cases the loan to value ratio will be 100% for first time buyers. Fortunately, most first time home buyers are eligible for the First Home Owner Grant, which can be used to pay the majority of the required mortgage insurance. In addition, first home buyers are exempt from stamp tax in some states.

In the event that a loan applicant is not eligible for the First Home Owner Grant and cannot afford a deposit of 20% or more, he or she will have to pay stamp tax and mortgage insurance, which often requires a loan with a loan to value ratio of more than 100%. If the borrower does not wish to pay these extra costs, he or she could ask someone to act as a guarantor. 

A guarantor is someone who signs an agreement stating that he or she will take responsibility for the loan repayments if for some reason the borrower can no longer pay. This person is usually a relative, but may also be a friend in some cases. The guarantor’s assets will be used to secure the loan, which can bring the loan to value ratio down to a percentage low enough to avoid mortgage insurance. In some cases, a guarantor may be needed in order to secure the loan at all. 

If a guarantor is utilized, he or she can either sign a guarantee for the full amount of the loan or for a limited amount. In a limited guarantee, the guarantor will be responsible for only the percentage of the loan needed to bring the loan to value ratio down to an acceptable level. For example, if the original loan to value ratio for a borrower is 95%, but the bank will only allow ratios of 80% or lower without mortgage insurance, the guarantor would need to sign for 15% of the loan amount so that the borrower can avoid the insurance premium. 

Loan to value ratios (LVRs) are very important tools used by lenders to make decisions and determine costs. A lender may only approve certain types of loans if their loan to value ratio falls under a set limit. In addition, lenders typically charge mortgage insurance premiums to the borrower when the loan to value ratio is above a certain percentage. Avoiding these extra costs can be very helpful, so sometimes it may be in a borrower’s best interest to seek out a guarantor.