Before we continue with our in depth look at the Home Loan process there is some important concepts which I want to cover off. Today we are going to have a look at Loan to Value Ratio (LVR), Lenders Mortgage Insurance (LMI), Genuine Savings and Guarantees. I would like to stress again that each Lender is different and how they apply each of these items will vary depending on their credit policy.
Loan to Value Ratio (LVR)
Loan to Value Ratio or LVR is one of the most basic concepts relating to home loans. The LVR is the amount of a loan as a percentage of the value of the asset it was used to buy and is calculated by dividing the loan amount by the value of the asset.
For example you have a house valued at $500,000 and you have $100,000 in cash for the deposit, then the loan amount you are looking to borrow is $400,000. Your LVR is calculated as follows:
$400,000 (loan amount required) / $500,000 (value of house) = 0.8 or 80% LVR
The higher the LVR the higher the risk for the lender. Each lender’s credit policy will cover up to what LVR they are willing to lend, depending on the type of loan product or loan purpose that is being applied for. For example for a standard home loan a lender may lend up to 95% of the property value, but for a low document loan they may only lend 70% of the property value.
Standard practice for LVR’s over 80% is for Lenders to require Lenders Mortgage Insurance, which leads us to the next topic.
Lenders Mortgage Insurance (LMI)
Lenders mortgage insurance (LMI) protects a lender against financial loss if you default on your home loan and the property is subsequently repossessed and sold. The LMI covers the amount left to pay on the loan if the amount recouped from the sale of the property is not enough to pay off the loan in full to the lender. Note that LMI protects only the lender not you the borrower from loss.
LMI allows borrowers to obtain a loan that would otherwise not be available, or to obtain a loan much sooner than they would be able to if they had to save for a larger (more than 20 per cent) deposit. Some of the key points for LMI include:
- LMI premimum is payable at settlement. It may be included in the loan amount borrowed or paid upfront.
- The costs of the LMI premimum will vary based on the size of the loan and the size of the deposit.
- It is not possible to transfer LMI between lenders, if you refinance your loan with a new lender you may have to pay a new LMI premimum
- If the LMI insurer has had to pay your lender an amount in accordance with the LMI policy, the insurer may then attempt to recoup that sum directly from you the borrower.
It us usual practice that Lenders will require LMI on loans with a LVR greater than 80%.
Genuine Savings
With high LVR’s, typically over 85%, a lender will require the borrower to show genuine savings. This means borrower must show evidence of regular savings over a defined period, usually at least 3 months. The lenders are looking for evidence that the borrower will be able to meet there loan repayment commitments when they fall due.
The types of genuine savings that can be typically accepted include:
- A savings pattern, e.g. regular deposits into a savings account
- Term Deposits
- Shares
- Gift
- Equity in an existing property
- Inheritance
The following type of savings are typically not acceptable forms of genuine savings
- First home owners grant
- Borrowed funds
- Sale of assets other than property (e.g. Motor vehicles)
Each lender will have their own requirements around Genuine Savings and what is acceptable as genuine savings and what is not.
Guarantee
A guarantee can give you a head start by making it easier for you to get into your home faster with the help from family members or others willing to assist. A guarantee allows another person, generally a family member to use the equity in their home as additional security for a portion of your loan amount. This means you may be able to buy a property sooner, and avoid having to pay the LMI premium.
The features of Guarantees include
- Buy your own property sooner
- Avoid paying the premium for LMI
- Maximise the amount you can borrow (in some cases up to 100% of the purchase price)
- Guarantors will generally be family members (typically parents), however lenders will often consider other guarantors and determine if a security guarantee may be acceptable
- Guarantors can determine what portion of the loan they will secure. Normally the guarantor will secure up to 20% of the loan amount.
Next week we will continue our look at the home loan process with an overview of the First Home Owners Grant and some of the other costs that you are likely to encounter