What You Need to Know About Loan to Value Ratio

A loan-to-value Ratio (LVR) is one of the terminologies you will encounter when applying for a car loan. It is one of the vital elements determining whether you will receive approval for your auto loan application and the interest rate you need to pay.

Therefore, it is incredibly crucial that you understand everything that it entails. Here is a comprehensive overview of the LVR.

What is a loan-to-value ratio?

The loan-to-value ratio is the total car loan amount you need to borrow against the value of that specific vehicle. In short, it is loan size against the value of the car. You can calculate the LVR by taking the total loan amount you want to borrow and dividing it by the value of the vehicle you wish to buy.

That is LVR= Loan Amount/ Value of the vehicle.

One thing to note is that LVR is usually in percentage. Thus, you will need to multiply by 100. The above calculation will give you a rate the lenders will use as LVR.

For example, if you want to get an auto loan of $66,000, and the value of the car you want to buy is $ 60,000 (where the additional $6000 is for insurance, on-road, delivery, etc.), your LVR will be 110%.

What is the importance of the loan-to-value ratio?

LVR plays a crucial role in establishing your borrowing power. Lenders will use this LVR to determine whether a certain loan is risky. Furthermore, lenders will use the LVR as a critical element in setting loan terms, such as the interest rate, the loan amount you can borrow, and the repayment schedule.

For example, if you have a high LVR, lenders will most likely set a high-interest rate for you. Generally, a low LVR is highly recommended by lending financial institutions. It is because vehicles serve as security for an auto loan.

If you default on loan repayments, selling the vehicle will not cover all the lender's costs because the loan amount will be higher than the car's value. Therefore, a high LVR is a risk to lending financial institutions.

Another vital thing to remember is that different lenders have varying maximum LVR requirements. Some lenders have a maximum LVR of 80%, while others may extend the percentage to a higher amount of 150%.

How to decrease the LVR of your auto loan?

Besides having a good credit rating, reducing your LVR increases your chances of loan approval and low-interest rates. Here are some ways you can reduce your LVR to increase your chances of being able to borrow.

1. Go for a cheaper car

Choosing a vehicle whose value matches the market rates can help you reduce your LVR. That could mean going for a cheaper vehicle without modifications. By going for a more inexpensive car, you stand to have a favorable loan.

Remember that you will still need to account for registration fees, insurance, and stamp duty. Therefore, ensure you do not lose money by purchasing an expensive vehicle that exceeds your requirements.

2. Consider making a down payment

A down payment can significantly reduce your loan-to-value ratio and is incredibly beneficial to anyone with bad credit. The general rule is that the higher your down payment, the lower the LVR. The opposite is also true; the lower the down payment, the higher the LVR.

3. Get a guarantor

Lenders favor low-risk borrowers. The best way to be a low-risk borrower is to have a guarantor. Ask your partner or parent to use their equity to help you secure a loan. A guarantor will help decrease your LVR, thus reducing your loan risk and interest rates.

What is the best LVR?

From a lender's point of view, a good LVR is a low one as it amounts to less risk. However, from the borrower's point of view, a high LVR is a good one as it symbolizes more money. Remember that the higher the LVR, the more money you will spend to repay your loan because of the high-interest rates and monthly payments.

In most cases, lenders like giving out low-risk loans. Therefore, they will likely reject your loan request if you have a higher LVR than their limit. However, if you have a good credit score, lenders will most likely approve a high LVR auto loan. If you have a bad credit rating, it would be best if you apply for a low LVR auto loan and make a deposit.

Can your LVR impact your car loan refinancing ability?

Yes, your LVR can impact your ability to refinance. If your car depreciates at a higher rate than your loan repayment, your loan-to-value ratio will increase. In such a situation, if you apply for an auto loan refinancing, your new lender will see the increased LVR as a risk. This risky loan does not mean the new lender won’t give you an auto loan, but you may receive it at a higher interest rate.

What other factors impact your LVR?

Before lenders approve your loan application, they will look into other factors. These factors will impact the maximum LVR and your ability to secure an auto loan; they include:

• History of employment: Lending institutions will want to know your employment history, especially if you have a high LVR. If you have a history of low income or lack steady employment, your maximum LVR will be affected.
• Active mortgages: If you have an active mortgage, lenders will take it into account when deciding whether to approve your loan. This is because the property market is subject to several external pressures. Thus, active mortgages make lenders more apprehensive about issuing additional loans to borrowers. It could lead to a high LVR.
• Credit score: If you have a good credit score, lenders will have a favorable LVR for you. A good credit score means you have a good track record of making on-time payments. Therefore, even if you fail to make a high car deposit, you can still have a good LVR.

Can one get an auto loan if their LVR exceeds a lender's tipping point?

Yes, it is possible to get an auto loan if your LVR is higher than the lender's requirement. However, you may need to pay an insurance fee to protect the lender. Also, note that your auto loan will have a higher interest rate, meaning high monthly payments.

Summing it up

The loan-to-value ratio will impact your interest rates and overall monthly payments. An ideal LVR is one that is lower than your lender's LVR maximum. Remember that large car deposits can help lower your LVR, meaning you will have access to lower-interest auto loans.