Buying property is no simple feat and there are several things to consider before making a purchase. One of those things is understanding what a loan-to-value ratio (LVR) is when taking out a home loan. Below, Canstar breaks down what an LVR means and how it affects you.
What is an LVR?
A loan-to-value ratio (LVR) is a measure of how much a bank lends against mortgaged property, compared to the value of that property. Essentially, it is the percentage of a property’s purchase price that a bank will allow someone to borrow.
An LVR is calculated by dividing the amount of your home loan by the value of the property. Below is an example of how to calculate an LVR, where the value of the property is the same as the purchase price.
In this example, the value of the property is $500,000 and you have a $100,000 deposit. This means, you’ll need to borrow $400,000 to purchase the property. By dividing the amount of your home loan by the value of the property, you’ll be able to work out your LVR in percentage form. In this case:
400,000 / 500,000 x 100 = 80%
It’s important to remember that the value of the property may sometimes differ from the purchase price, which may affect how much a bank is willing to lend you.
The lower the LVR, the better
Lenders will generally look at a lower LVR more favourably, as they have to take less risk – the idea being that it means you are less likely to default on mortgage repayments. Having a higher deposit (lower LVR) also means that you don’t need to borrow as much from a bank and that you have more equity in your home from the outset
What is a high LVR loan?
The Reserve Bank states that borrowers with a high-LVR loan of more than 80% (meaning a deposit of less than 20%) are “often stretching their financial resources”. High-LVR lending has a different definition in Auckland, where mortgages of more than 70% (deposits of less than 30%) are considered high-LVR. That is due to the much higher house prices in Auckland, compared with other parts of the country.
In total, New Zealand house buyers borrowed more than $615 million for loans with an LVR higher than 80%, so with a deposit of less than 20%, in October 2019. Of that total, $429 million was for first home buyers. High-LVR loans leave home loan borrowers vulnerable to potential future increases to interest rates, or to economic shocks such as a recession, if they are unable to make the higher loan repayments.
What happens if you are approved for a high LVR loan?
If you’re borrowing more than 80% of the property’s value, you need to be mindful of additional costs. If you are approved for a high LVR loan, in many cases borrowers are then required to pay a Low Equity Fee or a Low Equity Margin (LEM), or an extra percentage of interest charged on top of the agreed interest rate. You can read more on the difference between Low Equity Fees and LEMs, here.
Why do banks care about LVRs?
LVRs are a way for banks to control their investment risk, and there are two main reasons why they are a vital part of our home loan system in New Zealand.
First, the Reserve Bank of New Zealand (RBNZ) requires lending institutions to lend responsibly. This means not lending more money to people than they can realistically afford to repay. A lower LVR (a larger deposit) means a smaller loan for the borrower to repay, and the borrower also ends up paying a lot less in interest over the life of the loan.
Secondly, banking institutions have to adhere to LVR restrictions and stay below the “speed limits”. These speed limits constrain how much high-LVR lending banks can make overall and have been imposed to stop bad lending practices, tame the appetites of investors, and keep housing affordable.
There are some instances where borrowers may be exempt from the LVR restrictions. Learn more about how the LVR lending rules work by reading this Canstar’s article, here.
So what deposit do you need in today’s property market?
As a general trend, data from the Real Estate Institute of New Zealand (REINZ) shows, despite some more recent cooling in the property market, residential house prices are on the rise, from the top of the North Island to the bottom of the South Island.
When it comes to residential properties, here are the house prices you can expect at present and what you have to borrow if you want to put down a 20% deposit:
|Where?||Median Sale Price||20% Deposit||80% Loan|
|Bay of Plenty||$620,000||$124,000||$496,000|
Source: REINZ, Median Sale Prices, Residential Properties, October 2019.
No matter what LVR you have on your home loan, or the purpose of the loan, it’s important to make sure your loan provides outstanding value in terms of features and fees. Canstar’s comparison tools can help you compare home loans quickly and easily. Use our free comparison tool below, to see what’s happening in the home loan market.