Applying for a loan is often a stressful experience. Besides comparing various interest rates, you may come across terms and phrases that you are unfamiliar with, including the loan-to-value ratio (LVR). You may also find it helpful to get some guidance.
Overview of the Loan-to-Value Ratio
The LVR refers to the ratio between the amount that you need to borrow and the value of the property. To determine the LVR, you divide the amount of the loan by the value of the property and multiply by 100.
For example, if the home that you intend to buy is valued at $150,000 and you have a $30,000 down payment, your LVR is 80%. You need to borrow $120,000, or 80%, of the $150,000 value.
When you apply for a loan, Australian lenders view borrowers with a lower LVR as less of a risk. An LVR higher than 80% is often considered a high-risk loan. Additionally, you may need to pay Lenders Mortgage Insurance (LMI). You may find it beneficial to check out this example of the borrower’s LVR guide.
Low LVR Helps You Avoid LMI
The Lenders Mortgage Insurance is a one-time payment that protects the lender if you default on the loan. As a higher LVR means that you are a higher risk applicant, the LMI is often added to loans where the buyer has an LVR greater than 80%. However, even with a minimal down payment, there is a way to prevent paying the LMI.
High-risk borrowers may choose to use a guarantor loan to avoid LMI and high-interest rates. With a guarantor loan, you sign the loan with someone else, typically someone from your family. This person is the guarantor and guarantees to the lender that you will not default. Equity from the guarantor’s property is often used as collateral.
Some lenders in Australia also waive the LMI for applicants with a low-risk profession. For example, if you work as an engineer, doctor, lawyer, or accountant, the stability and pay of your job may allow you to avoid the Lenders Mortgage Insurance.
If you do need to pay an LMI, you may not need to pay the fee up front. Typically, the LMI is added to the principal balance of your loan and paid off throughout the life of your mortgage.
Your Credit Score Impacts Your Risk
Besides the LVR, lenders also look at your credit score, which is calculated based on your credit information. When you have a high LVR, a higher credit score may help you obtain a lower interest rate and possibly a lower LMI premium.
If you want to increase your ability to get good terms for your home loan, pay attention to your credit score. Avoid applying for any other loans or credit cards for at least six months before applying for a home loan to prevent lowering your credit score.
The less you need to borrow to obtain a home, the better your chances of getting a favourable interest rate. Before applying for a loan, you may want to lower your LVR by saving more money for a down payment, finding a home with a lower value, or applying the equity from an existing mortgage to your new home. If you cannot achieve a low LVR, focus on your credit score to avoid paying a high LMI.