March 16, 2017
When taking out a mortgage, of course you want to get the best deal possible. After all, paying even half a percentage point less for your interest rate can save you tens of thousands in interest over the term of your mortgage! One of the biggest factors that banks look at when determining your strength as a borrower and how much of a risk you are, is your Loan to Value Ratio, also known as the LVR.
Basically, it is the ratio of how much you are borrowing against the value of the property. When you have a low LVR, preferably less than 80%, you present a lower risk level to the bank, making you an excellent candidate for a home loan.
The reason your Loan to Value Ratio means so much in determining the quality of your loan, and even if you qualify or not, is that a low LVR provides a level of security to lenders. Looking at it from a bank’s perspective, if you want to purchase a home for $500,000, and want financing for most of that amount, they are taking on a huge risk if you can’t pay back your debt. They will have to incur the expenses of selling the property in order to get their money back if you go into foreclosure and will lose out on the interest payments they had expected from you as a borrower.
With, however, a low LVR, the bank knows even if you fail to pay your mortgage, they already have the security of your downpayment. $100,000 against a $400,000 loan is enough security to protect a lender against huge losses in the worst-case-scenario of default. Also, being able to save up 20% of your property’s value is an indicator of your own financial responsibility. You are much less likely to have trouble making payments in the first place if you have already proven your stability.
Determining the LVR is done by dividing the loan amount by the purchase price. Then, multiply this number by 100 to get your LVR. In order to be a strong candidate, you want your LVR to be less than 80%. More than this, and you’ll likely have to pay Lenders Mortgage Insurance and may not be eligible for the lowest interest rates.
When looking at properties that you are interested in, doing this simple calculation will let you know which homes you could buy with an 80% Loan to Value Ratio or less in other words, which homes you can afford where your lender will also offer you a good deal on your mortgage.
Take the average home price in Melbourne as an example $641,200. You would need at least $128,240 as a deposit in order to have a desirable LVR, leaving $512,960 for the bank to finance for you: $512,960/$641,200 x 100 = 80%.
Many homeowners refinance after they have built up enough equity in their homes in order to get a lower interest rate. If you have paid off 15% of the value of your home and originally put down a 15% deposit, then you may want to consider refinancing. In this case, you would have more security to offer a lender because you’d only need to finance 70% of the value of your home.
Keep in mind, when you refinance, banks will use the current value of your home to determine the LVR. If, for example, the value of your home increased due to the market or because you renovated your kitchen, your home is now worth more.
The lower your LVR, the less risky you will appear to banks. Still, many lenders today are offering competitive rates to Australian borrowers even with a higher LVR. Especially if you can demonstrate other factors to prove you’ll be able to pay off your mortgage, such as a high income and a good credit history, you can still get an excellent deal on your mortgage. You can also compare rates and refinance as you build up equity in your home down the line.
Written by Refinancing.com.au
Refinancing.com.au is an end-to-end service that helps people refinance their home loan. We empower you to search for your home loan, and choose the process that suits you.
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