The importance of the LVR
LVR or Loan-to-value ratio is one of the most important metrics lenders use.
LVR is the percentage of the secured property value you are borrowing. This metric is important to the lenders since it represents how much of the property value is available to repay the loan if they need to foreclose on the loan. It also is a key determinant to the interest rate that they offer you and if they require you to take out Lenders Mortgage Insurance.
Generally, you will find that the following will apply to different LVR bands.
>95% LVR – Only a select number of lenders are willing to lend at this LVR to owner-occupier for purchasing purposes only. There are generally no interest rate discounts. LMI is required.
90%-95% LVR - More lenders are willing to lend at this LVR. Only a select number of lenders are willing to lend at this LVR to investors. Not many lenders will lend for refinance purposes. There are some interest rate discounts. LMI is required.
90%-80% LVR – Many lenders are willing to lend at this LVR to both owner occupiers and investors and for both purchasing and refinancing purposes. There are some interest rate discounts. LMI is required.
<80% LVR – Many lenders are willing to lend to you. All offers have interest rate discounts. Interest rate discounts are the greatest. LMI is not required.
From a borrower’s perspective your starting LVR will make a significant impact on what to expect from your loan and how to plan for future refinancings.
Your starting LVR is a key determinant of how long you will be with your lender (assuming you do not sell the property). Since LMI premiums are paid upfront every time you finance, there is a disincentive to refinance until you LVR reaches below 80% LVR. You are also unlikely to find many lenders that allow you to refinance until you are below 90% LVR. Below is a general rule of how long it is expected to take to reach an LVR of 80% based upon different starting LVRs (assuming your property value increases by 2.5% p.a.) and provides an expectation of the timeframe you will be stick with your lender.
Expected time to reduce LVR to below 80% (assuming property value increases by 2.5% p.a.)
98% - 5 years
95% - 4 years
90% - 3 years
85% - 2 years
Given the above timeframes, it is important to understand how your needs may change concerning loan features and how interest rates may change over that time. The starting interest rate should not be the sole basis for choosing a lender.
Below are some of the issues to consider.
The most important loan feature you need to consider is an offset account. Place any surplus saving or temporary savings (e.g. for a yearly holiday) into an offset account can reduce the amount of time required to pay off your loan.
Interest rate type
Fixed rate loans – if you are considering a fixed rate loan, you should understand that the interest rate after the fixed rate period is usually a lot higher than most normal variable rates. If you are unlikely to refinance and the end of the fixed rate period, you will be stuck with a higher variable interest rate.
Introductory rate loans – In the US, these loans are called ‘teaser’ loans because they tease first home buyers on high LVRs into a very attractive low-interest rate over an ‘introductory period’ and which then stings you with higher interest rates after the ‘introductory rate period’. Most people don’t realise how long they will be stuck with the loan and they often cannot do anything until their LVR reaches below 80%. Lenders know this, and that is why they are happy to offer lower introductory rates.
Variable rates loans – Variable rate loans will change over time. The extent to which they change will depend on the lender and its business structure. Generally, lenders that fund themselves entirely from customer deposits should have smaller changes in variable rates than lenders that fund themselves from the wholesale market.