Understanding loan-to-value ratios

LVR is becoming more and more critical with every lender’s policy renewal for investment lending. Since APRA instigated significant changes in early 2015, to reduce the hefty balance of investors who were borrowing, our marketplace has been affected and some investors have been taken by surprise when it has come time to purchase. And not all of the surprises have been good ones.

The initial change that was palpable was the restriction on the LVR that banks would lend to. Lenders opted out of the 95 per cent marketplace almost overnight. Some reduced their maximum lending amount to 80 per cent and some remained at 90 per cent. What this adversely changed (aside from the circumstances of investors with limited equity in their own home/other properties), was the number of young investors embarking on their first investment purchase as their first property purchase. Commonly referred to as rent-vestors, this contingent were happily going about building their financial futures while house-sharing, living at home with parents, or renting a compromised property temporarily. Faced with the prospect of having to save not just 10 per cent of the purchase price (to account for a 5 per cent deposit plus stamp duty and purchase costs), but in some cases 25 per cent, many investors in this category found that they had to opt out of the investment property market and re-think their strategies.

The second challenge we’ve seen investors face as a result of the reduced LVR policy relates to lenders’ stringent adherence to what we refer to as ‘global LVR’. For those who have opted to cross-securitise their lending (i.e. combine all properties into one giant loan facility with one lender) and don’t have sufficient equity in their own home or other assets, lenders have requested the LVR is decreased; whether it be by additional contributions, principal payment inclusion, or divestment. This is never a pleasant situation for any investor to face and it heightens the importance of maintaining a cash buffer for such rainy days.

The third challenge relates to equity releases for the purposes of investing. If the amount of equity that was once available from existing investment properties is suddenly reduced, this can have a devastating effect on a long-range settlement (such as an ‘off-the-plan’ investment) if the buyer has not released the funds earlier and had them available. There are many risks associated with off-the-plan securities and this is just one of them. In addition, harsher LVR restrictions that lenders choose to apply on certain projects, buildings, postcodes and zones can also have dire consequences if the property purchase was only approved conditionally prior the policy change.

The fourth consequence that some buyers may currently face relates to what any real estate agent dreads: a valuation shortfall. This means that a valuer deems an unconditional purchase price an inflated price after the sale has gone unconditional. While this is very rare in auction situations (most valuers accept that the auction price is a true reflection of market value), I am aware of rare situations where a valuer has deemed the result an over-payment. Riskier still are purchases made prior to auction. Whether a dutch auction prevails, or if competing buyers fight it out in a boardroom mid-week, a valuer can deem a sale price ‘inflated’. Should this occur, there are often few avenues left for the buyer to challenge the valuation. Some may have a plan B and will pursue a loan with an alternative lender, but avoiding such an exercise in the first place is always preferable. Being mindful of LVR maximums is critical in this situation, and it is smart to ask yourself whether your plan B allows you to extend your LVR in your current pre-approved loan. While valuation shortfalls are uncommon, they are never welcome news.

LVR determines so much more than whether a lender could accept or reject a loan. It underpins cash flow, the level of risk a buyer can take on, the rate of acquisitions they could embark on if building a portfolio, and whether an investment or a home is the next purchase for them.