Loan-to-value ratio: it's important when buying an investment property

Loan-to-value ratio (LVR) is a critical part of a property investor’s toolkit. If you’re new to property investing, here’s a quick run down on the role it plays in an investment portfolio, and why you should keep an eye on it.

If you're looking to buy an investment property in Hamilton, it is essential to know the total lending debt across your portfolio—your LVR. Knowing this figure not only serves to indicate the “health” of your portfolio—especially in the eyes of the banks—but can also ensure you don’t overstretch yourself with any future purchases.

Most significantly, your debt level can impact on your ability to meet the current LVR restrictions for any new property you intend to purchase. Currently, they are set to a borrowing limit of 60 per cent (requiring a 40 per cent deposit or equity) for investors.

Say you have two properties worth $900,000 in total and an overall debt of $400,000 remaining. The equity—or portion of the homes you’ve paid for—is $500,000. In percentages, it’s 55 percent and your LVR is 45 percent. Both meet the bank LVR restrictions.

From here, you may decide to use your existing equity (rather than a deposit) to purchase another property worth $530,000. Now you have three properties with a combined worth of $1,430,000; a total debt of $930,000 (existing debt + new property purchase debt).

This leaves you with a 35 percent equity over your whole portfolio and an LVR of 65 percent.

As it stands, you’re in safe waters (just). However, if:

• your initial debt was higher—say at $500,000,
• you chose to purchase a more expensive property, or
• you chose to purchase a fourth property on top of the third,

you may find that your combined portfolio exceeds the LVR limits and the banks will not lend to you.

It’s this combined portfolio LVR that can catch investors out. While your equity will also grow with the value of your property, banks will not recognize this unless you get your properties revalued, and this can be costly. Moreover, if you’ve already purchased the home in question, the delay in getting your portfolio revalued could also cause issues in your ability to meet your settlement date.

All up, rental yield and loan-to-value ratios should never be overlooked when you sell or buy as an investor. To do so could jeopardize your home sale and place undue risk on your portfolio.