A loan to value ratio, or LVR, refers to how much you borrow (loan amount) as a percentage of the total value of the home or investment property you plan to buy.
If you borrow more than 80% of the bank’s valuation of the property value, the lender will want you to pay Lender’s Mortgage Insurance. This applies whether you are using equity or cash to purchase the property.
LMI insures the lender, not the borrower, in case of a default on the loan payments. It is a one off charge at the start of the loan and can often be added to the loan.
If the bank needs to liquidate the property and the sale proceeds fall short of what they are owed, they will recoup the difference from the LMI provider.
LMI is lender specific. In other words if you refinance at some stage and your borrowings are still above 80% of the bank’s valuation, the LMI is applied again.
The amount of LMI increases according to the level of risk perceived by the lender.The more you need to borrow, the higher the premium.
If at all possible, a minimum contribution should be 80% of the purchase price, with a buffer for a valuation shortfall + costs of 5%.
For example, presume you are wanting to purchase a $500,000 property. Ideally, you will need a 20% deposit or $100,000 plus 5% for your costs = $25,000, in total, $125,000 either in cash or usable equity.
If the lender assessed value of the property is $480,000, they will only lend you 80% of $480K or $384,000, $16,000 less than the $400,000 you had hoped for.
You have three options:
- Contribute another $16K cash or from your equity – assuming you have more money or ore usable equity.
- Up your LVR to 83% (400K/480K) and incur LMI.
- Look for another property and try again!
BUT not investing and capitalising on a good opportunity may cost more than the LMI in the long run! (Remember ‘Opportunity Cost’ is the real cost of the opportunity you didn’t choose)
Many lenders will fund up to 90% of the purchase including LMI and the LMI is tax deductible for the investor.
From the ATO:
“Borrowing expenses also include other costs that the lender requires you to incur as a condition of them lending you the money for the property – such as the costs of obtaining a valuation or lender’s mortgage insurance if you borrow more than a certain percentage of the purchase price of the property.” https://www.ato.gov.au/Forms/Rental-properties-2007-08/?page=13