There can be a lot of jargon in the financial world, and with brokers, accountants and whoever else using it all of the time, it pays to understand what is going on. So this week, let’s sort out LVR and LMI.
Although it might seem difficult, understanding all of the terms that come with property investment are actually surprisingly simple. It just takes a minute sitting down with a financial glossary to understand what is meant by a particular term. I’ve done all of this for you and made some notes on some of the most important terms in the property finance world.
Let’s kick things off with LVR.
LVR stands for Loan-to-Value ratio. It is a calculable ‘score’ that represents the dollar amount of a loan divided by the value of the property being purchased using the loan. LVR is typically used by banks as the basic component for calculating the risk of lending scenario. A higher LVR means a higher risk, therefore it has an enormous impact on the likelihood of achieving a loan approval.
So let’s give a quick example.
A property has a value of $600,000 and a home buyer is interested in purchasing it for their family’s residence. In addition to the purchase costs (stamp duty, legal fees, etc) the purchaser has amassed savings of $60,000 for their deposit. To get the remaining amount, a $540,000 loan would need to be taken up via first mortgage security from the bank. As such the LVR is $540,000 / $600,000, or 0.9. Therefore, 90% of the value of the home would need to be borrowed for the property to be purchased. This would be considered a high LVR as the bank is lending a high percentage of the property value.
The maximum LVR to purchase a residential property for owner-occupied purpose is generally 95%. The higher the LVR the more difficult it becomes to qualify for the loan as the lender tries to mitigate the risk by only offering these types of loans to applicants with an excellent credit rating, stable employment and high affordability. Banks will also price according to risk as use the LVR for this purpose. In other words, they’ll increase the interest rate when the LVR is high and sometimes offer extra discounts if the LVR is low.
Let’s now get on to LMI, or Lenders Mortgage Insurance.
Banks don’t like to take risks, and want to ensure that the money that they lend is returned with interest. This is what Lenders Mortgage Insurance is all about. To cover their backs when taking higher risks, a Lenders Mortgage Insurance premium is paid by the borrowers when taking mortgages over an 80% LVR. Yes the insurance protects the bank, not the borrower, but the borrower is charged the premium. This may seem unfair but is the same across the industry no matter which lender you select.
Continuing with the above example, the property being purchased was valued at $600,000 and the amount being borrowed was $540,000. The loan-to-value ratio is therefore 90% and because the LVR is above 80%, Lenders Mortgage Insurance is applicable.
Calculating Lenders Mortgage Insurance is a pain, and honestly, it is a lot easier to just use an online calculator. The premium depends on the loan amount, the LVR, and the bank that you are lending the money from as they all have differing arrangement with the insurers. In the example above, LMI comes to the value of $12,042. Many lenders will allow you to capitalise this cost which means that they’ll add the cost to the loan amount so that it’s borrowed and doesn’t result in extra savings being required. If the property being purchased is for an investment purpose your accountant will confirm that the associated cost is a deductible expense. It is possible to avoid the LMI fee entirely by using some clever finance options, such as the Family Pledge, but there are more steps involved and you would need another party to help you.
So that’s it! Everything you really need to understand about LVR and LMI is presented above. The next time you have a conversation with a broker about purchasing a property you will have a much clearer picture of what is going on.
Speaking about that, why don’t you get in touch with us and have a chat about your investment options?