Authors: Brian McNicol and Muthu Pannirselvam
Loan to Value Ratio is simply a way that the finance industry describes the amount you wish to borrow as a ratio to the percentage of the property’s lender assessed value or the lender’s valuation of the property. For example, if you were purchasing a $1million property and were going to borrow $800,000 then your LVR would be 80%. Eighty per cent is generally the tipping point for lenders before they then look at requiring Lenders Mortgage Insurance (LMI) although self-employed with no income evidence using low doc loans may only borrow up to 60 per cent before LMI is required.
Not all lenders will require a valuation and adopt the price on the Contract of Sale if certain criteria are met. These criteria may vary between lenders and from time to time but generally include a loan of 80 per cent or lower, the loan is under $800,000, you provide full evidence of your income, the property is in either a capital city or major regional centre, purchase through a licenced real estate agent, the property is not new or off the plan and you are not related to the vendor.
If the lender does require a valuation, either desktop, drive-by or by a registered valuer and that valuation varies from the purchase price, it will always be the lower of the contract price or the valuation. Some other examples of were a valuation is likely to be required is if you are purchasing off the plan or purchasing a property from a family member, maybe at a discounted price. Another example is when you are refinancing a property, the lender will have a valuation undertaken to confirm the value of the property.
Some smaller financial institutions like building societies or co-operatives may have a requirement that all properties are valued and have Lenders Mortgage Insurance.
Some financial institutions may also reduce the Loan to Value Ratio that they are willing to lend against if you have a default on your credit file or they regard the property as difficult to sell – estimated to take over 6 months – so the property may be unusual or unique, in a remote location or a heritage-listed property, a display home or a serviced apartment for example.
The Australian Prudential Regulation Authority (APRA) is the regulator that overseas various financial institutions and its key focus is on the stability of Australia’s financial system. In recent months, APRA has expressed concern above the high levels of borrowings, particularly interest-only loans so again the banks could change the LVR requirements to meet any APRA requirements. Lending institutions may also impose higher LVR based on postcode restrictions. Lenders may impose stricter lending requirements for areas that they consider high risk for example mining towns or metropolitan areas that they consider oversupplied with apartments.
There are also some professional investors who wish to borrow as much as they can, maybe 90 or 95 per cent LVR and are happy to pay the Mortgage Lenders Insurance so everyone’s circumstance is different.
As we have mentioned, lending institutions generally regard any LVR above 80 per cent as high risk. Prior to 1965, lenders would only lend on LVR of 80 per cent or less so the introduction of Lenders Mortgage Insurance has opened to door for the purchase of property that previously may have been out of the reach of people.
Lenders Mortgage Insurance (LMI) is insurance that a lot of people don’t understand. It is an insurance that the banks require to advance you the loan, it is paid by you but it only protects the lending institution. Unlike other insurances that you may take out such as house insurance, car insurance where you pay by the month or on a yearly basis, this insurance is a once-off for that loan. The premium can either be deducted from the loan amount or added to the loan amount. For example, if you obtained at $400,000 loan and were required to pay an LMI premium of $5000 then you could obtain $395,000 towards the purchase of the property and you would then need to fund the balance required to settle the property – deposit, stamp duty, bank fees and LMI shortfall or you could obtain the full $400,000 plus $5,000 making your total loan of $405,000 and pay interest on this amount. In the situation where the premium is added to the loan, the premium is said to be capitalised or capping the LMI premium. LMI Capitalisation is, therefore, the process by which the LMI premium is added on top of the loan. Capping the LMI premium means that you need a smaller input of funds.
Lender’s Mortgage Insurance can be a significant expense, particularly for more expensive properties and therefore should be included in any budget to acquire a property. The example that we have used above, whilst the premium is significant, it is not large. If we were to look at a $1million property and we wanted to borrow $950,000 (LVR of 95%) then with a large borrowing and a high LVR, the premium for the LMI is also going to be high, maybe between $38,000 and $45,000. The LMI premium generally comprises a percentage of the loan amount and a percentage of the property value that you are borrowing.
Lender’s Mortgage Insurance as we have said is not like other insurances and this is shown when it comes to selecting an insurance company. To be more accurate, if you want to deal with a particular company, and you have very limited choice, then you need to find a financial institution that insures with that insurance company. The paperwork for the LMI is undertaken by the bank as part of the loan approval process and will require the mortgage insurer to assess and approve your loan. Some things that the mortgage insurer looks for in an application is stable employment history, perfect credit history, good savings history and now, with the introduction of credit scoring in Australia, a good credit score.
Borrowers with little borrowing experience generally look at interest rates when choosing a lender but just as it can be is a rather short-sighted approach to choosing a lender for an inexperienced borrower, it can be very costly when it comes to borrowing with LMI. There is no regularly published premium rates for LMI readily available for an investor and rates vary depending on such things as the lenders, the size of the loan, the deposit etc. Unless you are using a good finance broker who will know which lenders they should approach in your situation, it is worth making enquiries with different banks to see what the interest, fees and LMI charges are likely to be. If a bank has a Delegated Underwriting Authority (DUA) or an Open Policy with the mortgage insurer, that bank is able to approve loans on behalf of the mortgage insurer and may approve a loan that the insurer may have declined or asked more questions about.
Remember, Lender’s Mortgage Insurance protects the lender not you the borrower if you through accident, illness, loss of employment are unable to make your repayments. It is different from loan protection insurance or mortgage protection insurance which does cover the borrower in the event that you are unable to meet your loan repayments.
Loan to Value ratio and Lenders Mortgage Insurance are just two of over 2000 terms that we have included in our book, Its My Time: The A-Z of Property and Financial Terms, available in good libraries, bookshops like Readings or from our website.