When a lender receives a loan application, one of the first things the assessor wants to know is how much they’re being asked to lend, and how that relates to the value of the security they’re being given to sell, should things not go so well.
More technically speaking, for a home loan, they look at the ratio of the loan amount to the security property’s value.
LVR stands for Loan to Value Ratio, and is simply the loan amount divided by the property value, expressed as a percentage.
For example, if you borrow $400,000 to buy a $500,000 property, and you use that property to secure the debt, your LVR is 80%. Your $400,000 loan is worth 80% of the $500,000 property value.
Why is LVR important?
It’s the first and clearest measure of how much risk the lender is taking. The higher the LVR, the higher the risk.
It’s important to the lender to consider what will happen if you stop repaying the debt for some reason. They mortgage on your property gives them the right to sell the property to recover the debt. When you add in the legal costs, any unpaid interest, the cost of a real estate agent and the chance they might not get as good a price as you paid for the property, it’s easy to see how a lender might lose money if the LVR was very high to begin with.
If you want a very high LVR (for example because you don’t have much deposit), it’s an expensive way to get a home loan, because of the extra risks the lender needs to mitigate, and it can also be harder to get it approved. The lower you can get the LVR, the lower the risk, and the more lenders compete for your business with lower fees and more attractive interest rates.
LMI (Lenders Mortgage Insurance)
Generally, if your LVR needs to be above 80%, the risk is high enough that your lender will take out an insurance policy to protect themselves against the risk, and you have to pay for it. It’s called Lender’s Mortgage Insurance. It protects the lender, not the borrower, and so it shouldn’t be confused with other types of insurances like Income Protection, Loan Repayment Protection, Life Insurance and so forth.
The further above 80% your LVR is, the higher the risk is, and so the higher the LMI cost, as a percentage of the property value.
The LMI premium is charged once, when the loan is created, and that premium is simply added on to the total loan amount. It can vary from around 0.5% of the loan amount if the LVR’s only just over 80%, to as much as 5% of the loan amount, if the LVR is 95% or thereabouts.
Think about that for a moment. 5% of the loan amount. That’s somewhere around a whole year’s interest, as an upfront cost. If you can avoid it, it is generally worthwhile.
How can I reduce or completely avoid LMI?
There are a variety of ways, but they all boil down to one thing: getting the LVR as low as you can. The closer you get to 80%, the lower the LMI cost, and if you get all the way to 80% or below, there’s no LMI at all.
Some ways to do that include:
- Buying a cheaper property with the same deposit you have (so that your deposit is a greater percentage of the property’s value). This is a difficult way to solve the problem as it takes a very big change in property value to have a minor impact on the LVR.
- Save up more deposit. This means you don’t have to borrow as much, dropping the LVR.
- Finding a way to include more deposit. You might want to buy with someone else who also has deposit saved up, or perhaps you know someone who is willing to “gift” you some deposit funds (give you the money you need to get a more attractive deal, and sign a stat dec saying you don’t have to pay them back). This is a common method parents use to help their children, for example.
- Use a guarantor. This means that the LVR is calculated using the value of the guarantor’s property as security too, not just yours. In other words, the lender has two properties they’re able to sell to recover the debt.
There are many technicalities to all of these options, and different options suit different types of people and scenarios, which is where your Mortgage Broker comes in.
At Mortgage Choice in Kingsley we’re across all the subtle differences between various lender policies, and are equipped with the knowledge and experience to help guide you to the solution that you feel is best for your individual situation. It’s the part of our job we love the most.
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