What is Loan-to-Value Ratio

Loan-to-value ratio is simply the comparison of the size of the loan taken to buy a property, with the value of the property. It is a risk assessment ratio for lenders. Also called the LTV ratio or LVR, it is one of the most significant indicators of the risk involved in a mortgage loan. This ratio is the first to be assessed by a lender before agreeing to clear a loan for a borrower. It is the calculated amount of the loan taken as a percentage of the total appraised property value. Thus a loan of $200,000 taken for buying a house worth $220,000 would have a LVR of 200,000/220,000 or 90.909%. It is a lending risk assessment ratio that helps lenders. For the borrower it is important since it determines the expense incurred in getting the loan, or the interest rate that will be charged by the lender for the loan.

The LVR has been devised by financial specialists based on the history of loan defaults so as to minimize the risk of defaults by borrowers. It is used by bankers and other lending institutions, and the lower the LVR, the lower the risk involved, making it easier for a loan to get sanctioned. An LVR of over 80% of the property price is considered to be more risky. Lower LVR means that the borrower is investing a larger percentage of his own funds to purchase the property and is therefore a safer party to lend to. Higher LVR indicates a lack of financial resources for the borrower to invest on his own, hence the need for a bigger loan to pay for the property. This makes it more risky since it places a doubt on his repaying ability.

Formula:

Loan to Value Ratio = Loan Amount
——————–
Appraised Value of Property

The value of the property in question is determined by a valuer on the lenders’ side, and does not imply the purchase price. There is a difference between the valuer’s price and purchase price.

A high LVR will get cleared for a loan only if there is a guarantor for the loan or the borrower has a strong financial position with equity and other property to show as his assets and can be placed as collateral. This can even clear an application for a loan of 100 % LVR.

LVR is also useful for lenders when they are considering application for refinancing a property. An LVR higher than 75% in case of refinancing will charge higher interest rates, though they prefer to refinance only up to 75% of the new loan amount asked and would like to see a certain minimum credit score.

LVR is not the only criterion used by lenders for sanctioning loans, since it not comprehensive enough. It has to be combined with other analysis and assessment of the credit worthiness of the borrower before the loan can be granted. However, it may prove to be the line that marks the difference between getting a line and being denied one.

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