13 Aug Loan to Value Ratio Uncovered – The Myths, Facts & Maximising Loans
In this week’s episode of the Rentvesting Podcast, we’ve got Louis and Jayden back together talking about loan to value ratio and working out how much is too much. It’s important to know how to use loans but also to know when it’s too much, the pros and cons of it.
Today we’re going to cover:
- How to maximise long term returns through leveraging as much as possible without receiving too many of the negative consequences
- The pros and cons of LVR
- Some tricks to get around them
- How to avoid LMI and get more education
How much is too much?
It’s important to know how much is too much with LVR and the more property you buy, the more debt you’re taking on.
What is Loan to Value Ratio?
It’s basically the loan to the value of the asset. You can have this with margin loans, for this, it’s home loans. So if you’ve got a property worth $500k and there’s $400k of debt, that’s 4 divided by 5 = 80%.
The LVR is just a percent of how much of an asset is built up to the loan. You can either have LVR if you’ve got no debt, otherwise, people might have 95 – 120%. Some people call it LTV which is loan to value in America they use that but in Australia we use LVR
What are the pros and cons of high LVRs?
The big con, in general, is if you have 80% LVR or more than 20% deposit, you don’t’ pay lenders mortgage insurance – but if you have less than 20% deposit you pay it. This is an additional cost where the bank will make you go with a third party provider to get insurance and add ons to your loan. It also increases your debt and it’s an insurance to cover the bank when you have a small deposit.
This premium allows you to get that product, the pros is that a lower deposit means you can get into the market quicker and more deduction because you’re paying higher interest rates. This is a double edge sword, assuming it’s an investment property, the more debt you have, the more interest and the more deductions. Otherwise, owner occupied you have less deposit and more nondeductive and non-tax effective debt but it can help you put your foot in the market.
It’s good on your cash flow up front because you don’t need to save us much upfront but bad long term because you’ll have more debt.
You’re more susceptible to asset price drops, so if you buy a property for $100k and you get an 80% loan, it drops by 15% in value, all of the sudden the loan itself is worth more than what the properties value is. You will struggle to sell it because the bank will say if you want to sell it you have to top us up for the difference in the loan.
The banks are more critical on your application with a smaller deposit, so there are more checks and balances because to the bank you’re a higher risk customer.
The rates are generally higher. With all the changes with APRA, the banks are pricing for risk, in effect, that means the lower deposit the higher the risk in the eyes of the bank. With higher LVR and less deposit, you pay higher interest rates, which is a con of higher LVR stuff.
Go study medicine – different types of jobs
White collar workers, like if you’re a doctor, vet, radiologist, optometrist – any medico type profession, can get up to 95% LVR without paying lenders mortgage insurance because these jobs are recession proof. The banks are willing to lend more to these professions because they’re earning potential will only go up.
This was recently extended to engineers, accountants, some forms of financial advisors. It’s an industry specialisation deposit, but different criteria and incomes change this.
Family guarantor loan
This is where the banks are happy to lend you money using a guarantors property as security, most people use their parents. Where in Louis’ scenario if you’re buying a house for $500k and you borrow it all, but the bank will put $100k loan to your parent’s property then $400k (80%) will be secured against yours. So the bank has two different loans. Because both loans are below 80% there’s no LMI and it helps you get into the market a bit quicker. The only negative is higher interest repayments because you’re borrowing more. If you’re on a high income and your parents can do this, it’s a good option.
This works well for someone who has been studying but has a big income, they can pay down 5 – 10% within two or three years and after that time they can remove that guarantee – they’ve paid down the 20% and move on.
Gifts from parents and relatives
You can use this as a deposit if you don’t have your savings. I don’t really advocate people using personal loans as a deposit because you get into too much debt. Personal loans have higher interest rates and shorter repayment periods. It’s better to get the lenders’ mortgage insurance.
Also, it’s potentially tax deductible against investment properties.
- High LVR is a really important tool, there are a lot of pros that should be considered. When I bought my first home I had a 5% deposit and paid $12k in mortgage insurance, moved in for 6 months and then after turned it into an investment property and claimed a deduction for the costs. So there are a lot of pros in there. I wouldn’t have been able to buy another property for another 2 years had I not done this.
- Going back to our last episode on the battle of property, if you can get into property with a 0% deposit, and experience the full return on that whole value, it’s a very powerful tool but it’s solely reliant on growth, which is never guaranteed.
- The cons of high LVR are if there’s a market correction it can really affect your equity.
- The banks have a lot more caveats and checks and balances in place because of its higher risk to the bank.