We’ve all heard the term LVR batted around in the media and by banks, but what exactly is a loan-to-value ratio? And what does it mean to the average lender?
Very simply, the LVR (or loan-to-value ratio) is how much you owe vs. how much the property is worth. For example, the house is worth $500k and you owe $300k, so the LVR is 60%.
The maximum LVR ratio banks will allow are different for the various types of properties you are looking to purchase (e.g. apartment, investment, owner-occupied) and are different again if the property is brand new vs. second-hand.
What LVR rules exist today?
The Reserve Bank said there are no restrictions or LVR rules for a period of time, and all of New Zealand got super excited. However, just like when a child says something silly and are patted on the head and told “there, there” in a patronising way, the banks have done the same and given the country a little pat on the head. Why? Because they all have their own risks to manage and strategy to navigate in the current climate.
You see, the banks can make up their own minds about their LVR policies (at least for the next nine months or so) and that’s exactly what they have done. Some did the opposite of what was expected and increased the amount of deposit or equity (we will get to these two things next) needed to purchase certain properties. While others have created opportunities to purchase with a lower LVR.
Deposit vs. Equity
A deposit is the cash you have available to use towards your house purchase. You either have it in your bank, in your KiwiSaver, or someone who really loves you may gift it to you.
Equity is the difference between what your property(s) is worth and how much you owe on the property.
When you currently do not own a property and you wish to purchase you will have a deposit. Once you own something and you want to buy something else, you are using equity (and you can top this up with more deposit).
How to Use Equity to Buy Property
Now, something that trips people up is the confusion around how to use equity. So, this might make those muddy waters clearer:
Imagine you own a property with:
· Value of $800,000
· Loan of $400,000
· And you wish to purchase another property for $500,000
You would need to get a new loan for the full value of the new property of $500,000 as well as pay the current loan of $400,000.
So, the end position is this:
· Total value of properties $800,000 + $500,000 = $1,300,000 (Value)
· Total Loan over both Properties. $400,000 + $500,000 = $900,000. (Loan)
The bank will look at the combined loan and combined value of the properties.
In this case the combined LVR is $900 000 / $1,300,000 or 69%.
In our example, it is likely (from an equity perspective) that there is sufficient existing equity to buy the $500,000 property without having to put in any extra deposit.
The key is knowing what the different requirements are for what you are buying and which bank has the most helpful LVR rules at the time (meaning that your current bank may or may not be the most helpful for your particular plans).
An important part of my role is to be up-to-date with all the changes the banks make in this space, and make sure you are at the best bank for you.
Lance Shearman is a Registered Financial Adviser with Velocity Financial. No investment decision should be taken based on the information in this blog alone. A disclosure statement is available free of charge upon request.