Fundamentals of debt - Borrowers equity required and Loan to Value Ratios (LVR’s)

Tuesday 18th January 2011 4:45pm

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The purpose of this article is to consider Loan to Value (LVR) ratios and their impact on borrower's equity when entering debt.

 

Equity is your friend when you enter the world of real estate investment.

 

Quite often, getting your first mortgage is the hardest part, but once you have some equity within your assets you can usually move on quite smoothly as an investor.

 

Loan to Value ratios are one consideration when you are first starting out in property investment.

 

A Loan to Value ratio (LVR) is the amount of a mortgage when compared to the value of the property it has been taken out on.

 

If you want to borrow $130,000 to buy a house valued at $150,000 then the LVR is 87% - meaning you are borrowing 87% of the value of the property - this would still be considered a good debt.

 

A situation such as this would see the borrower in "instant equity" before the new home has even been christened with a champagne toast, the borrower has borrowed only 87% of what the house is worth and therefore has 13% of the value of the property in equity.

 

When assessing borrowers for a mortgage banks take into account their income, savings history and amount of outstanding bad debt, but they also assess how much the property is valued at when compared to how much the borrower is hoping to borrow in order to buy it.

 

In this instance, a bank lender can often become your best friend.

 

If a bank refused to lend you money on LVR reasons, this is probably a blessing in disguise - no savvy property investor wants to borrow more than what a property is worth and start out in negative equity.

 

LVR ratios that are under 80% are thought to be "low risk", but this does not mean borrowers do not often come away with loans for full financing, or 100% LVR - the situation is not suggested and is usually reserved for credit-worthy borrowers, but it does happen.

 

The savvy real estate investor will want all borrowing to stay under the recommended 80% LVR.

 

This may not always be possible to the exact percentage, but the closer you try to get, the better.

 

Over-borrowing can be the undoing of many prospective real estate investors.

 

Be cautious about what you borrow, what you buy and how you buy it.

 

My Knowledge Tips

1. Equity is your friend when you enter the world of real estate investment.
2. A Loan to Value ratio (LVR) is the amount of a mortgage when compared to the value of the property it has been taken out on.
3. If a bank refused to lend you money on LVR reasons, this is probably a blessing in disguise
4. LVR ratios that are under 80% are thought to be "low risk"