Loan to value ratios are a metric commonly used by lenders to determine how much money they are willing to loan to a borrower. LVR is the loan amount expressed as a percentage of the value of the asset that is being funded.
It’s easiest to explain LVR using an example. If you need $500,000 to buy a property, an LVR of 80 percent would equate to a loan of $400,000 and you would have to provide the other $100,000 some other way. An LVR of 90 percent would be $450,000, and so on.
That explains what LVR is, but why do lenders use LVR?
What is LVR used for?
When lenders provide a loan, their loan is secured in some way. Usually, it’s secured against an asset which the lender can seize and sell to get their money back. When you get a mortgage, the loan is secured against your house, for example.
But lenders don’t want to provide 100 percent of the cost of the asset. This is because if the asset drops in value, the lender won’t be able to get all of their money back. To protect themselves against this, lenders only provide loans up to a certain threshold. This threshold is the loan to value ratio.
Loan to value ratios aren’t standardised‒it’s up to the lender to determine how much risk they are willing to tolerate, and set their LVR threshold accordingly.
This means that loans for different purposes are subject to differing LVR requirements. A lender might be willing to loan up to 95 percent on a mortgage. But for construction funding, LVRs are normally 50 to 65 percent.
As the LVR increases, lenders may start changing other aspects of the loan to compensate for the increased risk. Loans with a higher LVR also tend to charge a higher interest rate, which makes them more expensive for the borrower.
This is why funding a property development isn’t just as simple as going to a bank to get a loan. Banks won’t provide the full amount necessary to fund the whole project, and even if they did, the amount of interest charged just wouldn’t be cost-effective. As a result, many property developers raise capital from investors to fill in the gaps that aren’t provided by loans. ∎
