If you plan to buy a home soon and have begun your research, you’re likely to have come across terms like interest, principal, and loan to value ratio (LVR).
Your LVR is an important ratio, which impacts how much a lender loans you. So, what exactly is it and how do you calculate the loan to value ratio for a mortgage?
What is the loan to value ratio?
Your LVR is the percentage of the money you borrow or plan to borrow against the value of your property. It is used by lenders to determine your borrowing capacity.
As LVR increases, the risk to the lender also rises. Many banks and other lenders specify LVR limits as part of their qualifying criteria for a loan.
How to calculate LVR for a mortgage
The loan to value ratio is the loan's principal amount divided by the value of your property, multiplied by 100.
The principal amount is how much you'd like to borrow. The lender determines your property value by carrying out an independent valuation. Let's understand this better with an example.
If you want to borrow $500,000 for your house, and your property value is $600,000, your LVR will be ($500,000/$600,000) x 100= 83.3 per cent.
In other words, you could also consider the LVR as the portion of the property that isn't a part of your down payment. For instance, if you pay 25 per cent down on loan, your LVR will be 75 per cent.
To avoid complicated calculations, you can also use platforms that offer mortgage loan to value ratio calculators.
Why is LVR important?
LVR determines how risky you are as a borrower. If you have a high LVR, you may have to pay Lender’s Mortgage Insurance (LMI) as extra security for the lender.
How to lower your LVR
Two variables determine the LVR percentage—the loan amount and the value of the asset. When it comes to reducing it, you have a couple of options.
- A significant down payment: The more you pay upfront, the less you'll have to borrow. You also may avoid paying LMI.
- Affordable targets: Another option is to opt for a less expensive home. Initially, you might feel you aren't getting your dream home, but by choosing a more affordable option, you can reduce your LVR and cut down on your monthly payments.