Calculating your Loan to Value Ratio (LVR)
Over the last few years, regulations in the banking industry have been constantly changing.
After the tightening of rules following the Royal Commission, we are now grateful to see the winding back of Responsible Lending laws. Meantime – Best Interest Duty legislation comes into effect Jan 1, 2021.
With all the changes in the market – everyone wants to know:
- What do the banks want?
- How much will the bank lend me?
- How can I make my application more appealing?
When it comes to your loan and its chance of approval – your Loan to Value Ratio is a huge factor.
Loan to value Ratio (LVR) and Lenders Mortgage Insurance (LMI).
LVR and LMI – two acronyms that go hand in hand when you’re taking out a loan.
Let’s start with LVR. LVR is calculated by comparing how much is being borrowed against the total value of the property. So, in simplistic terms, if the property is worth $500,000 and you have a $400,000 balance then the LVR is 80% ie $400K divided by $500K. (And, your equity in the property is 20% ie $100K divided by $500K.)
The bank will obtain a valuation for the property to determine its value. It is important to note that when seeking finance to buy a property, the bank will then compare the valuation to the contract price and use whichever is the LOWER amount as the value.
It is also important to note that the property value is then increased by ALL costs including stamp duty, legals etc AND LMI. So, for example, if you want to buy a $500K house but there are $25,000 worth of costs and you have $100K to contribute so you need to borrow $425,000 then your LVR is $425/500K = actually 85% (and your equity is only 15%).
If your equity is less than 20% of the lender-assessed value, it means you have a Loan to Value Ratio of more than 80%.
This is where Lenders Mortgage Insurance (LMI) comes in. LMI is insurance that you have to pay for – but it only protects the bank if you default on your loan.
Different lenders have their own rules about when LMI is required – but it is generally needed when you have a Loan to Value Ratio of greater than 80%.
The actual cost of LMI can be difficult to estimate because it is a risk-based charge. So, the more you borrow – and the higher the LVR – the higher the risk – the higher the cost of the LMI.
As an example – For a $475K property loan at 95% LVR inclusive of LMI the LMI could be around $15k. A 95% loan at $660k could result in LMI of about $30k. LMI is always capitalised into a loan amount.
Loan to value Ratio (LVR) based on loan type
Want to know how much the bank will lend you? You need to work out what LVR there is.
Residential Property Loans
For a residential loan, the allowable LVR is higher than for commercial & rural properties. Keeping the LVR below 80% to avoid the cost of LMI is always a preferred option. But in some cases, the banks will allow up to 98% LVR. (Inclusive of LMI.)
With the increasing popularity of Tiny Homes, it’s important to note a property loan usually requires the house to be fixed to the ground.
Getting loans on transportable homes is more difficult and generally means that the LVR cannot exceed 80% AND the property usually has to be fixed to the ground before a lender will fund any of the loan requested.
Rural Property Loans
If you are looking at buying or refinancing a rural property, the LVR can range widely, depending on the circumstance – and the size of the property.
Properties up to 2.5 acres are generally treated as “rural residential”, so the LVR could be up to 90 – 95%.
Properties of up to 25 acres are usually classed “rural lifestyle” which means the LVR can usually go to 90%.
Rural blocks between 25 and 100 acres can occasionally be classed as “lifestyle blocks”.
When we head into the ‘above 25 acres’ territory, we see the field narrow quite a bit, with only a handful of lenders interested in providing finance and they can limit the LVR to 65 – 80%.
For these size blocks, you would need to provide details of how the property will be used and maintained. You would also need to detail why it is a ‘lifestyle’ property.’ This means there can be no mention of income producing activities – or it gets classified as “commercial”. Zoning of the property is also important here.
It is the lender’s discretion as to whether they will provide finance for these types of blocks. Their decision will be largely based on valuation – and how the Valuer has risk scored the property.
Hot tip: the time the properties in the area have spent on the market is a great indicator of risk. Properties that have longer than 6 months score very poorly and tend to be rejected by lenders. (That is, unless the LVR is very low.)
Properties above 100 acres and ones used for commercial purposes eg primary production usually require a 50-65% LVR. However, the lender’s appetite to do the deal depends greatly on the particular property:
- Where it is
- What it does
- What your tax returns are like e.g. other income sources. Are they up to date? Is there any tax debt?
Commercial Property Loans
The world of commercial lending is different, yet again.
In the main, any commercial lending starts at around 65% of the purchase + costs. Some lenders will go to 80% – usually only if there is either an owner-occupied home or investment home used as security against the commercial property loan (with enough equity in it to cover that difference between 65 and 80% as well as that property’s own borrowing remaining below 80%.)
As a general rule, commercial lending requires a repayment term of 15 years. However, some of the bigger lenders have recently moved some of their terms to 30 years.
This greatly depends on the type of commercial property. So we’re looking at what it is used for and what it could be used for.
The Right Loan for You
As you can see, the Loan to Value ratio guidelines change between each loan type which is why it is important to get the right advice, so you can apply for a loan that suits you. Need advice contact our specialist lenders at Crosbie Finance to find the best loan to suit your needs.