LVRs Under Review by the RBNZ

[Bobsyouruncle]

If things get hard banks will attack investment lending before PPOR.

[Frezzinghot]

If things get hard banks will attack investment lending before PPOR.

So in your opinion I should be attacking rental loans?

[Don't believe the Hype]

If things get hard banks will attack those who fall behind on their payments... make sure you have good cash flow and you're LVR is at a reasonable level and you'll be fine.

[Frezzinghot]

If things get hard banks will attack those who fall behind on their payments... make sure you have good cash flow and you're LVR is at a reasonable level and you'll be fine.

As a family, we are probably at our highest level of cashflow outflow as it will get, 2 teenagers at high school, one boarding at good school, the other local, one in primary. Costly time with school fees, clothing, cars, pocket money holidays...

So in the next few years the children move from this to the next stage we expect the costs to reduce, more cashflow, hopefully from trading, jobs, rentals.

So with time the most crucial ingredient, we will be better off.

FH

[lissie]

I recall some years ago being shouted down on this board because we've always kept our LVR around 50-60% :-) Feeling pretty comfortable now at 45%

[orion]

Hi All,

I have a current portfolio LVR of 63% across 3 tenancies, not looking to add to this yet as I am trading but wanted to know what would you all consider a safe level in the current market, especially now that all banks are looking for 40% deposits.

Cashflow is good at present so should I just sit and wait, also plenty of equity in PPOR so no pressure there either.

FH

Hi FH,

You may have already read the article I wrote last year on LVR's, if not I will put it here below.
Since writing this, mine has now gone down to 49% LVR which is comfortable, but wouldn't want to be too much higher.



Property Investing and Loan To Value Ratios (LVR’s).

The LVR or loan to value ratio is a percentage that the banks use as one of the factors in determining whether they lend money to you, or not. They also take into consideration your personal income, rental income, other debts you may have, living costs and credit cards etc.

For the past few years, the LVR that most banks and lenders consider fairly standard is 80%. Recently this has been lowered to 70% for properties purchased in Auckland.
What this means is that if you’re buying a property for say $500,000 and the bank’s requirements is an LVR of 80%, then the bank will lend you 80% of the $500,000 which is $400,000. The other $100,000 will be in the form of savings or equity from your own home, or possibly other rental properties.
If buying the same property in Auckland with banks only willing to go to 70% LVR, they would lend you $350,000 and the other $150,000 would come from you.

Debt to Equity Ratio
This is often used by people thinking it means the same as LVR, but it is very different.
Debt to equity is a term more used in businesses to determine how much debt they have compared to equity in the business. To work out what the debt to equity ratio of a business is, you calculate total debt divided by total equity.
So, if a company had $15 million in debt and total shareholder equity of $10 million, the debt to equity ratio would be 1.5 times or 1.5 to one (1.5:1)
Using it for property is not that common although some commercial banks/lenders may use it as a tool along with using LVR.

What is a good LVR to have?
The banks are generally happy if your overall LVR is under 80% for residential property (70% in Auckland) until you get to a certain number of properties, or type of properties owned. The amount of properties can be different with each bank, and can also vary depending on the relationship you have with your bank, and sometimes if another bank wants your business.
Some banks will reduce your overall LVR down to 65% if you have say over 5 residential properties with them, others may have their limit at 10 properties and others may say it doesn’t matter how many properties you have, as long as you have a good steady income from a job or business.
Others may not be concerned about the number of properties you have, but the overall debt you have with them. Some will treat you as a commercial business (borrower) if you have over $1 million debt with them and some may say they will go up to $3 million of debt before you are treated as a commercial customer, and everything then goes to 65% LVR.
Often banks will be more cautious of investment properties you want to buy outside the area you live in. They may require a different LVR, or a registered valuation, and sometimes not lend to you at all. Also if the property you want to buy is under $100,000 some banks will be very wary of this and may limit you to a 60 – 65% LVR, or again not want to lend to you for these type of properties.
Most banks will also treat a block of 4 or more flats as commercial, and therefore ask you to put in 35% as a deposit (65% LVR).
N.B. All commercial properties are generally treated as 60 – 70% LVR with the most common being 65%, so again a 35% deposit would be paid (or equity from elsewhere) to purchase any commercial properties.
Only a few years ago, banks were lending 90% and in some cases 95% on residential properties as well as rental properties, in other words a 90 - 95% LVR.

So, as you can see there are a huge amount of variables in all of this, and people will often think if their LVR is 80% or just under, they will always be safe.
To me, that is not only wishful thinking, but also very risky.

My LVR is currently 57%, which means 43% of the properties I have are owned by me and 57% is still owed to the banks.
The banks I deal with are very happy with this and say that the overall position and foundation of my whole property portfolio is now the strongest and most solid it has ever been. One said it was one of the most solid on their books throughout the whole of New Zealand! I was at first rather pleased with that, but then thought, really?

To me, there is still way more risk there than I am comfortable with and I want to get my LVR down below 50% as soon as possible. Ideally this will happen within the next two years by selling off a few properties (ones that were bought as trades several years ago) and paying down debt further.
Eventually, the plan is to have my LVR at 0%, that is - no debt.

To me anything over 60% LVR if you have $5 million or more worth of properties has some risk. The higher your LVR is, obviously the higher the risk is.

This is what I would suggest as a guide for looking at your own LVR:-
Up to $1 million of property – 80% LVR
$1 million - $2 million - 70% LVR
$2 million - $5 million – 65% LVR
$5 million - $10 million – 60% LVR
$10 million - $15 million – 55% LVR
$15 million - $20 million – 50% LVR
Over $20 million – 40% or less LVR

What happens if the banks changes their rules?
This can happen at any time as we have already seen with Auckland properties now needing a 30% deposit as opposed to a 20% deposit for the rest of NZ. As mentioned there was a time not so long ago that banks were happy lending over 80% and in a lot of cases up to 95% on purchase price. Some 2nd tier lenders will still do this for those that want it or can meet their criteria. The interest rate is generally a few percent higher to cover their risk, and is not something I would recommend for any investors to use.

If the banks changed their rules again to say for example, you now had to have 40% equity (a 60% LVR) across your whole portfolio, what would you do if you were now geared at 80%? You’re only option would be to sell or come up with a large amount of cash from somewhere else. If a lot of people were in the same situation, property prices could fall drastically until people came into line with the new rule. Or if too many people were being forced to sell, the rules may eventually be eased once again.

To have a strategy of buying properties whenever prices go up, and always leveraging up to an 80% LVR, gets more and more dangerous the longer it continues.

Property is a long term investment, and not something you can get rich from over night. The higher your borrowings get up to, your LVR should keep coming down to safer levels as shown above.
Even though property is a long term investment, the rules and regulations can change very quickly. These can come from changes with the IRD rules, changes in government regulations for property, or changes in bank requirements such as debt servicing, LVRs, or even higher interest rates being charged on investment properties, as an example.

What could happen to make the banks call in your loans?
I heard about an investor in NZ many years ago that had all 99 properties they owned with one lender, and that particular lender went into receivership. The properties were quite highly geared around 80% or so and the investor could not refinance them in time with any of the other banks, and therefore all properties were sold at mortgagee auction, and he lost everything.

But could your bank call in all your loans? This is something that can happen to anyone at anytime. If you read the small print, a bank can ask for all their money back!
It is unlikely that a bank would do this without good reason. But there are many instances when they can ask you to reduce your exposure with them.

For example, they may think the properties you have mortgaged with them are now worth less when they reviewed your portfolio the previous time.
This has happened many times to even very successful investors I know. All of a sudden the bank reviews your property portfolio and it shows up that a new E-Value for one of your properties is less than what is was the last time they did it.
They could ask you to get new valuations, pay down some debt, or reduce the limit on any revolving credit accounts you have with them, to bring it back into line with their rules. If you are not able to do any of those things, they will ask you to sell your property or properties.

I’ve had times over the years when a bank has said to me that they were reducing the maximum limit on my revolving credit facility, because the values of some of the properties I had mortgaged with them had dropped. Even a small drop of 5 – 10% in value of your properties could have a significant effect on your overall position if you are highly geared.

What can happen to change your LVR?
When I started investing over 25 years ago, I had saved $25k and the property I bought as a rental was purchased for $128k. I also had to borrow another $10k to keep the bank happy, which was on interest only from a lawyer, just to make it work.
In theory, my LVR was 80%.
The two loans totaled $103,000 ($93k bank plus $10k lawyer) and the $25,000 deposit was from my savings ($103k/$128k = 80%).
At the time I purchased this rental property, the bank had asked for a registered valuation. So I paid for a valuation and it came back and said the property was worth $128,000.
So I say in theory, as I found out a little later on that the property was worth a lot less than the $128,000 I paid for it, more like $100,000. I eventually sold it for $98,000 several years later.
This means if it was only really worth $100,000 at the time I bought it, my LVR was actually around 100%!

In this case, my LVR wasn’t what I thought it was. If the bank had realised that as well, they could have asked for more money from me to bring my LVR back to a comfortable level, most likely they would have wanted around $20,000. At the time, it would have been impossible for me to do that as I was a mechanic on low wages and didn’t have any spare money, let alone $20,000.

Apart from not knowing what your property is really worth if you had to sell it again (false valuations), there are a few other more obvious things that can change your LVR.

These will reduce your LVR:-
Paying down debt on your loans
Selling a property from your portfolio (unless there’s more debt on it than you sell it for)
Values of your properties increasing

These will increase your LVR (and increase your risk):-
Borrowing to buy more properties
Borrowing money against property to live on, purchase vehicles, or buy other liabilities
Values of your properties decreasing

This may sound all rather scary to you, and potentially it can be very scary.
Or you might even think none of this will ever happen to you, and so you are in denial about the dangers of having high debts and a high LVR.

Others will hopefully realise that investing can be done with relatively low risk by using a bit of common sense and also plan for what could happen. This could be from changes in rules or policies, property prices remaining static for long periods, or properties going down in value - which does happen at times.

Don’t aim to get as close as you can to your banks’ limits or rules. These can change at any time and by attempting to go to another bank - you might find their rules and regulations are even more strict.
Any small changes in the banks’ policies, changes in law, your personal income, or any slight drops in property prices could affect you drastically - when it really doesn’t need to affect you, providing you are sensible and have good money habits.

Safe investing.

[Bobsyouruncle]

So in your opinion I should be attacking rental loans?

I don't think there is a right or wrong answer. Paying your PPOR is a risk mitigation strategy and is tax efficient. Comes down to what makes you sleep best at night. But if you are concerned about another GFC style economy, the banks forced us to sell investments but not our own home so making sure your portfolio isn't over leveraged is a sound position to be in.

[mortgage broker]

The best LVR really depends on your personal situation and your plans for the coming years, unfortunately with the strategy adopted by the RBNZ, it becomes harder to plan. The safest way to incorporate any type of control is to have split banking.

Some clients will have to sell their entire portfolio to trade up their owner occupied home now.

[Mr_B]

Hi there, I'm speaking to my broker later in the week to discuss my potential plan ahead. But am interested if someone can answer the below question.

My current PPOR is valued at say ~1.2mil and my mortgage is 200k. I see that as an LVR of ~16%.

If I were to use equity on my home to buy 4x200k IPs (to keep the maths simple).

My overall debt would be 1mil and total house value 2mil so an overall LVR of 50%.

If I am with the same bank for my PPOR and 4xIPs, how does the bank see my individual LVRs?

Because in debt terms my PPOR will still be 200k and each of my IPs 200k.

So I'm effectively 100% geared on the IPs (from a debt perspective), but is 40% per IP still classed as deposit by the bank?

So PPOR is 16% LVR and 4xIP is 60% LVR?

[Don't believe the Hype]

If you're using same bank they will cross-collateralise the debt so will take total debt as a function of total value - if that is under 60% you will be fine based on LVR requirements.

if you want to keep the PPOR excluded from the collateral on the investment - redraw from PPOR 40% of the purchase price of the investments and buy the investments with a 40% cash deposit. Slightly different set up but means your PPOR is not used as security.

if you use the same bank for investments as PLOr they may not want it set up like that as it's less security in their eyes.

[Mr_B]

Ok thanks.

So I have just moved my PPOR over to one bank and they want security for the IPs, so its looking like cross-collaterised debt and the individual LVRs are not relevant?

I'm trying to understand under what circumstances the bank could potentially force a sale of one of these properties.

Say the potential upcoming downturn significantly impacts my Auckland PPOR value. This will no doubt have a knock on effect to my IPs and my current LVR %.

Have the banks in the past forced sales when this occurs, even if I am in a secure job and paying down P&I on all my properties and they are self sustaining ie require no top ups from me?

If you hit the LVR limit is that a big no-no for the banks irrespective of your current circumstances, or do they only care about that if you choose to sell and they take a cut to keep them happy?

[Grads]

I would suggest if anyone is selling to utilise funds / proceeds from sale, check with lender 1st amount required to repay once security is sold..

For example during the GFC lenders would ensure they reduced debt / loans (total exposure) to meet their requirements ie more funds than loan amount for particular property sold.

[Frezzinghot]

This is what I would suggest as a guide for looking at your own LVR:-
Up to $1 million of property – 80% LVR
$1 million - $2 million - 70% LVR
$2 million - $5 million – 65% LVR
$5 million - $10 million – 60% LVR
$10 million - $15 million – 55% LVR
$15 million - $20 million – 50% LVR
Over $20 million – 40% or less LVR

Hi Orion,

Yes I remember reading this, very insightful and makes complete sense, I have been investing for quite a while now and still only manage a 63% LVR in the Auckland market, value of portfolio 1.2mil. But I do wander what LVRs the new investors will have now especially if they have purchased in the last 2-3 years, this is a big reason I decided to trade instead of add to the portfolio as I knew if I added to the portfolio now my LVR would take a big hit, time in the market has allowed my LVR to reduce so want to keep it that way.

Only way I can see to reduce LVR overall is to trade my way out, as income is paying for kids, PPOR, clothing, holidays.

As a side note, I have seen a few friends looking at and purchasing land on coastal areas for holiday homes, surely this is unwise as these types of investment get hit first is a downturn.

FH

[PTILoveYou]

41% and dropping....

[Nick G]

Maybe 50% right now. I'd like to make one more big buy this cycle and lock in rates, will have to sell something now.