Loan to Value Ratio or ‘LVR’

The LVR is the percentage of the property’s value that is in debt. Most banks and financial institutions are willing to lend you up to 80% of the property’s value (80% LVR) but you can go as high as 95% in some cases.

Example 1 - Available equity at 80% loan to value ratio (LVR)

Your home value - $300,000

80% of home value - $240,000

Less existing debt - $200,000

Available equity at 80% loan to value ratio is $40,000

Example 2 - Available equity at 95% loan to value ratio (LVR)

Your home value - $300,000

95% of home value - $285,000

Less existing debt - $200,000

Available equity at 95% loan to value ratio is $85,000

Evidently, there is a great deal of difference between the equity at 80% LVR of $40,000 and the the equity at 95% LVR of $85,000.  Therefore, your property investment goals may come to a screaming holt unless you consider some more advanced finance strategies rather than the 'normal' 80% LVR rule.  

Watch this short clip on Loan to Value Ratio (LVR)

Debt Service Ratio or 'DSR'

The bank will also consider your serviceability when it comes to giving you a loan. Serviceability is often expressed as a ratio being your ‘DSR’ or ‘Debt Service Ratio’, as the bank calculates whether they believe you can afford to ‘service’ or repay the loan. The ratio determines how much of your income will be needed for you to be able to repay the loan.

The most common types of loans are either – ‘Full Doc’ – where you prove your income and expenses to the bank,

‘Low Doc’ – where you nominate how much you earn in order to service the loan without providing traditional proof of income such as pay slips. Instead you would generally supply your personal or company financial statements, or,

‘No Doc’ – where you declare to the bank that you can meet the payments for the loan without having to prove what you do or don’t earn. As of 2009, these loans are virtually non-existent due to the financial crisis experienced in late 2008.

(*Doc means documentation or evidence)

Many factors can influence your serviceability, the most common being:

Your job – Are you fulltime, part time or casual, how much do you earn, and how long have you been in your current job?

Your other income – Do you have any other income like rent from investment properties, or government benefits like family tax allowance?

Your expenses – What are your current loan commitments such as home loans, investment loans, credit cards and personal loans?

Your marital status, and do you have children? - Banks factor in more expenses if you are married and have children.

Current interest rates - Are they likely to rise in the near future and what effect will a rise have on your abilty to meet repayments on all of your loans?

Of course there are many more factors that can apply in different situations.

All Banks use a loan ‘serviceability calculator’ to tell if you will meet the banks criteria for serviceability before you go to the trouble and expense of applying for a loan.

In many cases some banks also factor in the following which can impct the amount you can borrow :

- Only 80% of the estimated weekly rent (of the new purchase)

- An interest rate of 2% above the standard variable bank rate, to ensure you can still meet repayments if rates rise, and

- All repayment calculations based on Principal and Interest repayments, as the loan balance will reduce over time, something the bank likes to see happen.

Australian banks have some of the tightest credit policies in the world, so if you have been truthful in your application (not over or understating your existing commitments) and the bank says you can afford the loan, you should have no problem in servicing the loan over the long term.

Lenders Mortgage Insurance or 'LMI'

Lenders Mortgage Insurance or LMI can allow an investor to use to use less deposit when purchasing a property, but can also be used to obtain more of the equity in your other existing properties.

In both cases, the bank will charge you LMI for the privilege of borrowing more than 80% of the properties value.

LMI is an insurance premium you pay on behalf of the bank, for the bank to get insurance in the event you can’t pay your loan. Many people believe LMI covers them in the event they default on a loan – it does not, it only protects the bank. If you were to default the bank would get the money from the insurance company and the insurance company would come looking for you!

It’s for this reason many banks and brokers advise against going above 80% LVR, as they believe it’s an unnecessary expense. However, the smart investor uses LMI as a tool which enables them to expand their portfolio faster buy using less money as for each purchase. LMI can also be tax deductible over 5 years when the money is being used for property investment.

As can be seen in the table we could pay a 20% deposit and be up for $70,990 in total which would avoid paying any LMI premium, but if we did not have that amount of cash or equity available, we could choose to use a 10% or even 5% deposit which lowers the overall deposit substantially.

Many people may baulk at paying a $6,270 LMI premium (example only) for using a 5% deposit which is understandable. What the professional investor investor considers is the time cost of this money. A 5% deposit will allow you, the investor, to buy an investment property by using only $32,290 to cover the deposit and purchase costs (table above).

If you wanted to avoid paying LMI by waiting until you had 20% deposit and costs, you would either have to save a further $38,700 or wait until your home had an increase in available equity of this amount. In both cases, it could take a number of years for that happen, during which you would be missing potential growth oppurtunity on the purchase. It’s also likely that by the time you saved this extra amount in cash or equity, the price of the property will have increased, meaning you will need even more deposit anyway. 

Prowealth Running Account

A Prowealth Money Running Account pays the holding cost without any contribution from you and can be as excellent way to hold more property if cash flow is an issue.

It's the ideal way to ride through the peaks and troughs of the market - buying time and/or provides a cash buffer or safety net if things go wrong.

HOW DOES IT WORK?
Lets assume Property 1 has an out of pocket cost of $115 per week ($6,000 per year)

This is the money you would normally have to put in yourself.

By setting up the Prowealth Running Account, you can pay the shortfall from this account without having to dip into your own pocket.

This loan has many features and benefits - too much to explain here, so call Prowealth Money for more information.