For many Australians, homeownership is one of the most significant financial decisions they’ll make. We understand how overwhelming it can be, especially with terms like Lenders Mortgage Insurance (LMI) and Loan-to-Value Ratio (LVR) frequently coming up.
Let’s break them down to help you understand what they mean and how they affect your home loan.
Understanding LVR: What does it mean for your home loan?
The Loan-to-Value Ratio (LVR) is the ratio of your loan amount to the property’s value. It’s a measure lenders use to assess the risk of the home loan – the higher the LVR, the higher the risk for the lender.
The lower the LVR, the more you benefit from a lender offering a lower interest rate. Lenders are more open to providing a competitive rate for lower LVR because there’s less risk for them.
A common misconception when it comes to LVR is that it’s only significant at the time of the loan approval. However, it also influences the interest rate and overall borrowing costs.
Borrowers with lower LVRs (below 80%) are often rewarded with lower interest rates, saving thousands of dollars over the term of the loan.
Rules vary from lender to lender. For the most up to date assessment, speak with your mortgage broker.
How is LVR calculated and why is it important?
The Loan-to-Value Ratio is calculated by dividing the loan amount by the property’s purchase price and multiplying by 100.
LVR = (Loan Amount ÷ Property Value) × 100
For example, if you’re borrowing $500,000 to buy a $625,000 property, your LVR would be calculated as below:
LVR = ($500,000 ÷ $625,000) × 100 = 80%
How do I find out what my loan amount will be?
Calculating your loan amount is not as simple as the purchase price minus the deposit amount. There are many other fees added to the overall cost of the property including conveyancer costs, bank fees and stamp duties.
The stamp duty is a tax State Governments across the country charge for every property purchase and is a significant addition to the property purchase. The cost varies depending on which state you’re in, the price of the property and if you’re a first home buyer purchasing a property less than $750,000. Follow the link for more information on stamp duty.
Is there a cap to the LVR granted?
The LVR percentage allowed by a lender will vary and multiple factors are taken into consideration including:
- The home loan amount
- The location of the property
- Your credit history
- Your income and employment history
- The type of loan you’re applying for
In other words, every scenario is different and working with a mortgage broker will help identify all the options available to you and your unique circumstances.
Borrowers with higher LVRs over 80% are often required to pay Lender’s Mortgage Insurance (LMI) to mitigate risk for the lender. Let’s take a look at LMI and what it means.
What is LMI and how does it work?
Lenders Mortgage Insurance (LMI) is often misunderstood as something that benefits the borrower. In fact, LMI is designed to protect the lender in case the borrower defaults on the loan. If you are unable to repay your mortgage and the property is sold for less than the outstanding loan balance, LMI protects the lender.
How is LMI calculated?
It depends on your location, the lender and the deposit you’ve saved which all needs to be taken into consideration to calculate the LMI.
As an example, on a loan of $500,000 with an LVR of 90%, the LMI premium could be as high as $11,000.
When is LMI required in Australia?
LMI is often seen as a one-time cost, but this isn’t entirely true. While LMI is generally paid upfront, it can also be added to your loan balance, which means you’ll be paying interest on it for the life of the loan. Borrowers who opt to add LMI onto their loan may end up paying more over time due to the interest.
For instance, if you add a $10,000 LMI premium to your $500,000 loan, that amount becomes part of your principal, increasing your overall repayments and total interest paid. It’s important to consider the long-term impact of LMI, as it can significantly increase the overall cost of the loan.
Ultimately, LMI allows you to buy a home with a smaller deposit, but it adds to the total cost of your loan. For a typical home loan, this extra cost can range between $5,000 and $15,000, or up to 3% of the total loan amount.
The amount you pay also depends on the lender you choose and the insurer associated to that lender. Some banks self-insure while others have a third-party insurer. The insurers vary massively and could impact a difference of $9,000 in price to your home loan.
However, there are benefits to LMI. If you don’t have the full 20% deposit, it’s a way to get into the property market quicker. Without LMI it would be much harder to get a mortgage without the full deposit amount.
How can you avoid LMI?
First and foremost, the best way to avoid LMI is to save at least 20% of the property’s value. However, this is a lot of money which is not always possible. There are other options you can explore.
- Use a guarantor
If a family member is willing to guarantee your home loan with their property, you may be able to reduce your LVR and eliminate the need for LMI. It’s worth noting this is an option with some lenders, not all of them.
- First home buyer’s scheme
Those eligible for the first home buyers’ scheme can purchase a property with as little as 5% deposit without having to pay LMI. You can learn more about the first home buyers’ scheme.
- LMI Waivers
Depending on your profession, you may be eligible for an LMI Waiver.
Legal and medical professionals can apply for an LMI Waiver because they’re considered low risk borrowers due to their high earning potential and stable career path. You can learn more here (link to other blog post)
For those who have managed to save a 15% deposit, you may be eligible for a LMI Waiver from lenders such as Ubank and Athena. However, it’s worth noting that the interest rates may be higher with this deal.
Third Party Advice
Both LVR and LMI play crucial roles in shaping the terms of your home loan. By understanding these factors and using strategies to manage them, you can save thousands of dollars over the life of your loan.
Here at Loanscope, we can assess your Loan to Value Ratio and let you know if LMI is required. We always work closely with our clients to help them understand their options and secure the best possible terms for their next property purchase.
Take advantage of our home loan calculator or contact us today for impartial advice.
