Check the transcript of the video here:
Hello. I’m Maciej Stanek, Senior Financial Adviser and Director at Véurr. Today I’m explaining the loan to value ratio, or what’s called L V R for short. This term is used to describe the size of a loan as a percentage of the underlying asset that the loan is for.
It is commonly used when talking about loans on properties. The best way to explain this is by way of example.
If a property is worth $500,000 and a lender offers a loan of $400,000, $400,000 divided by $500,000 is 80%. So, the LVR on this scenario is 80%. In my opinion, this is a relatively high LVR, but I’ll explain the risks of a high LVR later.
There are two ways to reduce the LVR. The most common is by making regular repayments on the loan. If a loan gets paid down from $400,000 to say $250,000, and assuming the house value remains the same at $500,000, then $250,000 divided by $500,000 is 50%. So, the LVR in this scenario is 50%.
If a properly actually increases in value from, say, $500,000 to $1 million, and the loan remains the same, $400,000 divided by $1 million is 40%. So, the LVR of this scenario is 40%.
Both these scenarios are good for wealth creation. What if the opposite occurs? What if the property falls in value instead of increasing?
Take the same initial example, but instead of a property going up from $500,000 to $1 million, it instead falls from $500,000 to $400,000.
Now the debt is $400,000, and the underlying asset is $400,000. $400,000 divided by $400,000 gives an LVR of 100%.
And if by any chance the property fell even further in value and the loan remained the same, the LVR would exceed 100%.
This is a wealth destruction scenario, and if the individual in this scenario cannot make loan repayments, then the lender will confiscate and sell the underlying asset to recover as many funds as they can from the money that was lent.
Any unrecovered funds would still be the borrower’s responsibility. This is a scenario where the individual is now left with a loan obligation and no asset for their troubles.
It is a situation that I try and help all of my clients avoid as it is extremely difficult to recover from. Calculate your own LVR and get in touch for expert financial advice.
