LVR. This snappy little acronym is one of the most important things you should know if you’d like to buy or refinance a home. Why? It’ll help you understand how much you can borrow, how to get the best rate and what risks you might face when you borrow. That’s a lot for three little letters!

What does LVR mean?

LVR, meaning loan to value ratio, is the percentage of what you borrow compared to the value of your home.

How do you calculate LVR?

Working out your loan to value ratio is a simple equation. It’s your loan amount, divided by the appraised value of your home, multiplied by 100 (to make it a percentage).

What isn’t included when calculating LVR?

Before you start calculating LVR, note that upfront costs are not included in the loan amount. Costs like conveyancing and stamp duty should be removed from the equation.

Let’s take a look at calculating LVR in real terms.

You’ve just signed a contract for a home with a $500,000 purchase price. You have $100,000 saved for the deposit (on top of all other costs like stamp duty, solicitor, fees, etc.), so you are planning on borrowing $400,000. You will be borrowing 80 per cent of the purchase price, because $400,000 divided by $500,000, multiplied by 100 is 80 per cent.

If we were in a maths class, your equation would look like this: ($400,000 loan ÷ $500,000 property value) x 100 = 80% LVR

Assuming the lender agrees that the value of the home is the same as the purchase price, that makes your LVR, or loan to value ratio, 80 per cent.

If you have more or less than $100,000 set aside for the deposit, then your LVR will be different. If your deposit is $150,000, then your LVR will be 70 per cent. If your deposit was $50,000 then your LVR will be 90 per cent.

I’m ready to buy. Does borrowing above or below 80% LVR matter?

Now that we’ve covered what LVR is, let’s dig a little further into the detail. You’ll find 80 per cent is a bit of a magic number when it comes to LVR.

Depending on whether your loan to value ratio is above or below this, you’ll find yourself facing different borrowing conditions and different risks.

I’m borrowing up to 80% LVR – what should I know?

Borrowing up to 80 per cent LVR gets you better rates because there’s less risk for the lender. They aren’t lending you the full (or nearly full) amount of the value of the home – you’re putting in 20 per cent or more of the value of the home upfront with your deposit. And a smaller loan to value ratio makes the lender feel a bit more comfortable that they’ll be likely to get their money back should something go wrong.

Having an LVR of 80 per cent or lower will also mean you don’t have to pay Lender’s Mortgage Insurance (LMI). The process is also usually a little bit easier at up to 80 per cent LVR. The lender valuation could be a quick and simple desktop valuation.

Instead of sending someone to view the actual home to assess the value (which can take time), a credit assessor may use a computer-based system to estimate the value. Easy.

I’m borrowing over 80% LVR – what should I know?

Borrowing over 80 per cent of a home’s value means LMI will start to kick in. LMI stands for Lenders Mortgage Insurance and it’s an insurance cost you need to pay because your loan is a greater risk to the lender (the loan amount is closer to the valuation – leaving them with not much wiggle room if something goes wrong).

It comes in the form of a one-off insurance premium, which a lender will pass onto the borrower, to protect the lender against any losses it will face if you are unable to repay your home loan. The cost gets added to your total loan amount, and doesn’t need to be paid out of your deposit. But it does add to the overall cost of your loan.

Above 80 per cent LVR you will often find that available interest rates will go up. Meaning that your borrowed money will cost you more in repayments. And if you’re buying pre-auction or at auction with a planned higher-than-80 per cent LVR, be aware of the risks associated with valuations from lenders that may affect your ability to actually borrow.

With no cooling-off period and no option to increase your LVR, you might find yourself in a tricky situation if the lender values the home at less than the purchase price.

What happens if the valuation comes back less than I expected?

If you’re planning on borrowing up to 80 per cent LVR, you’ve got yourself a little buffer should there be an issue with the valuation. If the lender doesn’t agree with the price you are committed to paying (that is, values the home at less than the purchase price), you could still borrow more to cover the difference.

In our scenario above with a $500,000 purchase price, if the lender’s valuer decides the home is only worth $450,000, then for 80 per cent LVR they will likely only lend you $360,000. So, this means you’ll either have to increase your deposit to $140,000 (instead of $100,000) to cover the difference. Or you could consider borrowing at 85 per cent LVR.

At 85 per cent LVR, the lender will lend you $382,500, which brings you closer to your original deposit amount. Of course, the lender will take other serviceability factors into account, so you’ll need to double-check this with them.

At over 80 per cent LVR, this will usually mean the interest rate goes up and there will be LMI applied, but at least you know you can settle and not be at risk of losing your deposit.

Is there any benefit to paying LMI?

Paying LMI can be valuable in some instances. If saving for the difference would delay you from buying your first property for a number of years, then the cost of LMI doesn't look so bad in perspective.

How can I reduce my LVR?

There are other ways you can lower your LVR. You could ask a parent or family member to become a ‘Guarantor’ on your loan. Your guarantor uses the equity in their own home to safeguard your repayments.

A guarantee is a promise by the guarantor that you as the borrower will keep to all the terms and conditions of your loan. This means if something happens and you can no longer comply with the terms and conditions of the loan – meaning you can’t pay your mortgage – the guarantor promises to pay the lender all the money owing under a loan (and any reasonable enforcement expenses) as soon as the money is asked for. If you submit your home loan application with a guarantor, LMI may be waived.

The other way to reduce your LVR is to look at other ways of increasing your deposit. This is where planning ahead becomes your best friend. The sooner you start saving towards your deposit, the better. If you intend to buy a property in the next few years, calculate how much you want to spend, as well as your ideal LVR, then start putting these funds away.

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