Since the Global Financial Crisis (GFC) many ‘high risk’ lending products and practices of the past have ceased to exist and / or credit requirements tightened. However, lenders still want your business and creatively develop products for those with minimal deposits.
You may have seen the acronym LVR, particularly when looking to borrow money to purchase property.
But what does it mean?
Loan to Value Ratio simply refers to the proportion of money you borrow compared to the value of the property. Lenders will consider your LVR before agreeing to lend you money and use this ratio as a way to assess your risk as a borrower.
The higher the LVR, the more risky you are to the lender.
LVR is calculated by dividing the Loan Amount Required (property price – deposit) by the Appraised Property Value (hopefully similar to the purchase price!).
For example, if you were buying a property costing (and valued at) $500,000 and had a $100,000 deposit, your LVR would be 80% ($400,000 loan / $500,000 property value)
The general rule of thumb is a 20% deposit against the value of the property, hence LVR of 80%.
LVRs above 80% are considered high risk and will usually require you to incur additional Lenders Mortgage Insurance (LMI) costs to secure your loan. This is to protect the lender (not you) in the case of default.
Having minimal deposit or no deposit can get borrowers into trouble; particularly if house prices decrease or your situation changes – it is not a nice situation to be in when you owe more than your property is worth!
Glenn Stevens, the governor of the Reserve Bank of Australia has warned borrowers about taking on too much debt, reminding them that whilst property prices can rise; they can also fall. Borrowers could get burned when interest rates or unemployment starts rising.
If you decide to use a low / no – deposit loan to purchase a dwelling to reside in, you really need to consider how you will make the repayments if you haven’t been able to save a deposit.
Conversely, these types of loans can be beneficial for an investment property purchase. The LMI can often be capitalised with borrowing costs, deducted over a 5 year period. This strategy is certainly worth considering for investors looking to acquire income-producing assets without having to have a 20% deposit each time.
An alternative to payment LMI on LVRs is a Guarantor Home Loan. This requires a party separate to the transaction (usually a family member) agreeing to use their property as security for your loan.
This might seem like a wonderful gift for parents to give their children, however the risks must be thoroughly understood and considered. The biggest risk is that if you default on the loan, the guarantor will also be held liable and worst case scenario, could lose their property which was used as security to obtain the loan.
In summary, high risk lending pre GFC has changed. The products available today need to be carefully understood by borrowers before jumping in to large amounts of debt that you cannot afford. You need to think about the risk and potential risk to your family.
On the flip side, these loans can grow your property portfolio much quicker than trying to save a 20% each time. As with all property decisions, due diligence, planning and risk management are key to successfully taking advantage of financing products available.