Loan to Value Ratios

The final element in a bank's determination as to whether or not to grant credit revolves around the loan to value ratio or LVR. The LVR is really a measurement of the risk that the bank is prepared to take. The higher the LVR the higher the risk and more careful the bank will be.

When it comes to first home buyer’s banks will lend to a maximum of 95% LVR, the very top of the exposure range. In these cases the bank takes a very stringent view and assesses every loan in minute detail. There is simply no margin for error in these cases because of the high risk so banks will make sure every element of the assessment process is carefully ticked off.

This means that employment conditions would have to be verified, even to the extent of the bank phoning the employer to verify that the applicant actually works there. All savings must be carefully documented and proved with account statements on the banks letterhead, and credit history reports are carefully examined to ensure that there are no defaults or any adverse listings, even the smallest amounts.

The important point to note about loan to value ratios is that whenever the LVR exceeds 80% the bank will insure the loan. This means that the lender is covered in the event of default by the borrower because the insurance policy makes good any losses the bank suffers. The term mortgage insurance is more accurately described as lenders mortgage insurance because the protectionist for the lender not the borrower.

The ironic part about this process is that the borrower has to pay the premium! This is regarded as a cost to the bank and they feel obliged to pass this on to the borrower because they would not be ensuring alone if it wasn't for the borrower's requirements.

In fact Lenders Mortgage Insurance can be the most expensive part of a home loan application especially for first-time buyers or anyone who wants to borrow up to the 95% margin. At this level, depending upon the loan amount, the premium can be as high as 2.5% of the loan amount. On a loan of $400,000 a premium of almost $10,000 will be payable, so you can see just how expensive this can become.

Here is a summary of the characteristics of loan to value ratios.

Banks can lend up to 80% of the value of the property being purchased without the need for lenders mortgage insurance. This means that a borrower only has to satisfy the bank's lending policy to qualify for a loan.

When the loan to value ratio goes above 80% the bank insures the loan with a lenders mortgage insurance company who charge premiums on a sliding scale increasing with the LVR up to a maximum of 95% where the premium will be costed at approximately 2.5% of the loan amount.

The borrower is required to pay the mortgage insurance premium at the start of the loan and the premium will be deducted from the loan. The insurance policy is a single premium policy meaning that there are no further payments to be made apart from the initial instalment.

Where a loan is paid out within two years, applicants may apply for a rebate of part of the mortgage insurance premium.

For commercial properties, each application is considered on its merits but as a general rule a bank will not go beyond an LVR of 70%. Less desirable properties for remotely located properties will only attract an LVR of around 50%.

For home loan refinances, the maximum LVR considered by any bank will be 90%. On some occasions some lenders may go as high as 95% but in stringent economic climates LVR's tend to remain low.

Occasionally, the assessment may throw up an added risk to the bank for instance where the valuer notes that there is a risk that the property may not retain its value for the next two or three years. During the global financial crisis valuers became much more conservative and began commenting about the uncertainty of future values. In these circumstances banks became more strident in their assessment and on some occasions were only prepared to lend on a reduced value.

For example, a property with a contract price of $500,000 located in a remote area on the outskirts of a major capital city may receive some adverse comments from the valuer. The bank could decide to limit the loan to 85% of the value of the property.

This means that the borrowers have to come up with extra cash to complete the purchase or abandon the loan completely.

The intricacies of loan to value ratios will be specifically explained to you by a mortgage broker or a lender at the time you apply. If you have any doubts about the worth of your property because of its location or recent sales history in the area, it's best to obtain a preapproval before proceeding so that a valuation can be done to clarify the situation.

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