In 2017 alone, first-time homebuyers made up approximately 32 percent of all home purchases. For mortgage brokers, that means more people taking out loans which is great for the bank’s bottom line.
But for homebuyers, it means that lenders can be a bit more selective in the types of loans they offer borrowers. The sooner a new homebuyer understands what lenders are looking for, the better prepared they’ll be to find the right type of mortgage.
Lenders consider everything from your income to your credit score when deciding if you qualify for the mortgage. But they also look at the property itself.
The house you’re interested in can impact whether or not a lender wants to offer you a mortgage in the first place. Why? Because of the loan to value ratio.
Wondering what this means as a first-time borrower?
In this guide, we’ll go over everything you need to know about the loan to value ratio and how it impacts your mortgage options.
The Loan to Value Ratio Defined
Before you get a home loan, the mortgage company will look at the value of the property and compare it against the amount you’re asking to borrow. This number is known as the loan to value ratio or LVR and is displayed as a percentage score.
The actual value of the property is not necessarily the asking price of the house. Instead, it refers to the value of the home as established by a formal home appraisal.
If you’re interested in a particular property, you’ll need to have it appraised before buying the house anyway. Otherwise, you risk paying too much for the home.
For the LVR, that appraisal value is then further reduced by the amount of your down payment. So, the actual value of the property minus your down payment is the actual property value your bank is interested in.
The higher the actual value of the property is and the lower the amount you’re borrowing, the better the loan ratio will be. You can calculate LVR for your dream house to see what you’re up against before speaking with your mortgage lender.
Understanding What LVR Means for You as a Borrower
For first-time homebuyers, LVR can be a huge deciding factor in whether a bank offers you a home loan. When you have a good or low LVR, lenders will be more willing to commit to the loan.
Low LVR scores (80 percent or less) show that the property has enough equity to make the loan worthwhile for the bank. These homes are low-risk properties that can be sold to recover the loan principal should you fail to make regular payments and default.
If the LVR is high, they’ll be less likely to offer you a mortgage. Why? Because a high LVR (anything over 80 percent) means the property doesn’t offer the bank a lot of equity. The loan is risky and if you default, they might not make up the full principal amount by selling the house.
If a bank does agree to offer a mortgage on a property with a high loan value ratio, they may charge you a higher interest rate. Over the life of the loan, that higher interest rate will cost you thousands of dollars.
What to Do to Offset Bad Loan to Value Ratios
If the lender determines that the ratio value is too high, it might seem like you won’t be able to get the house you want. But that’s not always the case.
There are some things you can do to make the investment look appealing to that lender.
Raise Your Down Payment
Increasing your down payment reduces the amount of money you borrow through the home loan. Remember, the loan to value ratio is based on the value of the property against the amount you’re borrowing.
The less you borrow, the better the LVR will be.
Look into Getting Help with Your Down Payment
For first-time homebuyers, there are great down payment assistance programs that will make it easier for you to get into the house you want.
These programs offer a small loan separate from the traditional mortgage. You then use this loan to cover the down payment for your property.
Money is money to most mortgage lenders. If you can supplement the down payment assistance loan with cash you have saved up, it might be enough to lower your LVR.
Keep in mind, this will involve taking out more debt which can impact your credit score. It’s up to you to decide if it’s worth the risk.
Take a Step Back
If the ratio is too high, it might not be the right time for you to buy the house. Instead, consider taking a step back and building your savings to cover more than the 20 percent standard down payment.
The more money you can pay towards the house, the less you’ll need to borrow in the first place.
Loan to Value Ratio is Not the Only Deciding Factor
Lenders use the loan value ratio to get an idea of whether or not the mortgage is in their best interest. But that doesn’t mean it’s the only thing they look at.
Your credit score, income level, and overall debt is just as important to the bank.
Even if a property has a relatively high LVR, you may still qualify for a fair home loan. Your best bet is to make sure everything else is in order before applying for a home loan.
If you have a low credit score, start working to improve it. If you have tons of outstanding debt, make payments and get those balances as low as possible. This will make you look like a better investment when you decide to apply for a mortgage.
And remember, ALWAYS shop around with different mortgage lenders. Just because one bank denied you outright or offered an insanely high-interest rate doesn’t mean others will.
As a first-time homebuyer, it’s important to do your research and find the best lender possible.
Your loan to value ratio is not the only factor that lenders use to decide if you qualify for the mortgage. But it is an important one.
The more you understand how your financial situation impacts home loans, the better prepared you’ll be to find that perfect house.
Need more tips to help you get your finances in order? Learn more here!