Over recent years banks have increasingly employed the practice of adding Low Equity Margins (LEM) to home loan interest rates when they are lending for housing purchases with less than a 20% deposit.
These margins are applied as an additional margin to standard housing rates to offset the higher bank funding costs associated with lending with low deposits however are seldom, if ever, reviewed proactively by the banks as the Loan to Value Ratio (LVR) reduces and ultimately goes below 80% at which point any LEM should be removed entirely. These LEM’s are applied at a rate depending on the LVR at commencement of the loan, the higher the LVR, the higher the LEM. Different banks have their own scales however a typical LEM band can be:
LVR Range LEM Applied
80.01% - 85.00% 0.30%
85.01% - 90.00% 0.75%
90.01% - 95.00% 1.30%
It is important to keep a close eye on your LVR through the first few years of your mortgage to ensure you are getting the benefit of reduced LEM costs as your LVR reduces through the respective LVR bands at which point most banks will allow you to reduce your LEM margin. Your LVR can reduce in 4 ways:
- Increasing market value of your property – with a constant or reducing loan balance, your LVR will reduce as value increases
- Reducing your loan balance through normal principal and interest (P&I) payment
- Reducing loan balance by one-off or irregular lump sum payments in addition to normal P&I payments
- A combination of any of the above
If we look at scenario 2 above and assume there has been zero movement in property value (albeit most unlikely, particularly over the past 3-4 years), if you have purchased your home with a 10% deposit (90% LVR) on a standard 30 year term housing loan from the bank, it takes 7.4 years of standard payments to reduce your loan to 80% LVR and 4.2 years to hit 85% LVR at which point you qualify for the 80.01% - 85.00% LEM rate. In reality, in a rising market, you will achieve this lower LVR point sooner than this hence it is important to keep in close contact with your property value at all times and test your LVR against any increased property value and/or reduced loan balance. This is simply worked out with the following formula:
Your total housing loan balance (A)…divided by…Your current property value (B) i.e. A / B = LVR
How do I know what my Current Market Value is?
All banks have different ways of determining this however most will accept a current Capital Value as issued by your local Council, an e-valuation from QV.co.nz or if this is not sufficient, a ‘desk top’ valuation from a reputable valuer and worst case, a new market valuation from a reputable valuer. Your friendly team at Onion Home Loans would be happy to advise you on these options which will vary depending on which bank you have your mortgage with and individual circumstances.
When can I ask the bank to reduce my LEM?
Again, all banks have different policies in this regard however most will allow you to reduce or remove your LEM at any point so long as it is more than 6 months after your most recent LEM adjustment. This applies whether it be floating or fixed rate
Benefits of reducing your LVR to 80% asap
There are obvious interest savings to be gained each time you can reduce your LEM against a lower LVR band however your greatest gain will come when you can reduce your LVR to 80% or below. At this point you don’t only remove your LEM altogether, you also then qualify for bank ‘special’ rates which most banks advertise against various fixed term rates at various times. These rates are not available when an LVR is above 80%, the banks use their ‘standard’ rates as the base for adding the LEM.
As an alternative to LEM, a few banks charge a non-refundable, one-off Low Equity ‘Fee’ at commencement of the loan however the LEM approach is the more common option. This can be a better option if you don’t see any significant value increase or ability to pay down your mortgage to achieve a 80% LVR in the short to medium term. Again however, you won’t qualify for ‘special’ rates until you reach the 80% LVR threshold.
As always, for reliable and friendly home loan advice, please call us on 0800 38 48 48 or visit us at Onion Home Loans – our advice is FREE!