Understanding Loan to Value Ratio
The loan to value ratio (LVR) is a measure of the size of a loan relative to the value of the asset being purchased. Lenders examine this ratio to assess the risk of lending money to a borrower. The higher the LVR is, the riskier the loan is perceived to be. In the next section we will discuss what is LVR in the context of car finance.
How LVR impacts car financing options
The LVR represents the loan amount as a percentage of the value of the car being purchased. Generally speaking, lenders prefer a lower loan to value ratio, as it reduces their risk. It is important to understand not only what loan to value ratio is, but also how it can impact many elements of your loan.
Below are just some of the factors that need to be considered if your LVR is on the higher side:
- Higher Interest Rates:Â lenders typically charge higher interest rates for loans with a higher LVR. This is because the higher the ratio, the greater the risk for the lender that the borrower will default on the loan.
- Limited lender options:Â Lenders will often have a threshold on the ratio they will accept e.g. some lenders will not lend to borrowers with an LVR of over 80%. This limits the options for the borrower.
- Higher risk of default:Â when borrowers have a higher LVR, it means that they are borrowing a large portion of the total value of the asset being purchased, which makes it more difficult for them to repay the loan if they default on it or if the value of the asset decreases.
- Negative equity:Â When a borrower has a high ratio, it increases the changes of the car having negative equity, meaning the value of the car is less than the loan taken to purchase it. This means if the borrower wants to sell the car before the loan is fully repaid, they will have to pay the remaining balance of the loan out of pocket.
- Limited future financing: a higher LVR can limit the borrower’s ability to refinance or borrow more money in the future, as the lender may be unwilling to provide additional financing when the borrower has not built up enough equity in the asset.
- Size of deposit:Â by increasing your initial down payment and putting more money down upfront, the loan amount will be smaller in relation to the value of the car. This is the simplest way to reduce your LVR.
- Car value:Â the value of a car can be determined by a number of things, including the make and model, the age of the car, and its condition. Lenders may use a professional appraisal or a pricing guide to determine the value. Be sure to shop around to ensure the value is accurate for the condition of the car. The higher the value of the car, the lower the LVR will be.
As you can see from the list above, a high loan to value ratio can increase the risk for both the borrower and the lender, making it vitally important that you grasp what is loan to value ratio before taking out any financial products.
Example
Here’s how it works: let’s say you want to buy a car that costs $20,000 and you have a down payment of $6,000. This would mean that you need to borrow $14,000 from a lender. The loan to value ratio in this case would be 70%, since the size of the loan ($14,000) is equal to 70% of the value of the car ($20,000). This would be considered a relatively low LVR.
Now let’s say you only have a down payment of $1,000. This would increase the loan amount to $19,000, and thus the LVR to 95%. This would be considered a higher risk loan, as the borrower will have less equity in the car. As a result, the lender may charge a higher interest rate or require the borrower to purchase additional insurance or warranty products to offset the risk.
In summary...
The loan to value ratio is a crucial metric used by lender to determine the risk of a loan. It represents the relationship between the amount of the loan relative to the value of the asset being purchased. The LVR can impact the interest rate of your loan, as well as limit the lenders available to you. Ensuring you understand LVR is essential to get the best loan terms.
For more information on what does loan to value mean for your loan and your situation, contact a Fido Finance qualified and reliable auto finance broker by visiting us online or calling the team at 13 34 36.
