The price is right – why are bank valuations important?

What’s happening with bank valuations?

Did you know that how a bank values a property largely determines whether you can buy it or not? Why is that?

If you’ve been in the market to buy property, you’ve probably heard of the term LVR – which means Loan to Value Ratio. The LVR relates to the amount that you are borrowing normally expressed as a percentage of the value of the property that you use to secure the loan.

For example, if you’re buying a property valued at $700,000 and you’re borrowing $560,000 then your LVR is 80%. If you’re borrowing $595,000 for the same property, then your LVR increases to 85%.

From your bank’s perspective, a low LVR means less risk and a high LVR means more risk. So if the LVR is high, your bank may require you to also pay for lenders mortgage insurance. Lenders mortgage insurance covers the bank for the difference in the outstanding loan amount and the sale amount, should the bank ever have to repossess and sell your property because you didn’t repay your loan. In fact, if the LVR is considered too high, your bank may even reject your loan application.

Naturally, property valuations follow the market, meaning valuations are determined according to historical sales data. Generally, properties are valued according to the sale prices of other similar properties in the same area. This means that as the property market goes up (or comes down as the case may be), actual valuations may differ or at least trail behind the sales price from time to time. For example, there’s a delay between selling a property and settling that transaction, so the record of the sales price does not occur until a few weeks or maybe even a few months after the actual sale. You could say that the valuations then are largely a historical record of what the comparative sales prices were, rather than what they are. Of course valuers attempt to include projections based on trends, but I think for the most part the benefit to the bank would be maintain a relatively conservative approach. Regardless, the expectation is that as the property market goes up and property prices increase, the perceived or recorded valuations are likely to be lower than the actual sales prices at any one time.

Although anecdotal evidence suggests that the demand in recent weeks may have come back a bit compared to what it was say 6 months ago, the perceived increase in the valuations are here to stay (for now at least). At the time, in order to support the market, people were buying with a higher LVR because their valuations were short of their valuations. To complete the transaction, they either had to contribute ‘more cash’ than expected or buy with lenders mortgage insurance.

During those months, our experience was that many valuations had been lower and clients had to contribute more funds/equity into their purchases – but those transactions have been settling, which means they too set the market and subsequently influence valuations to come.

Ultimately you must have money to buy property (regardless of how good your lawyer or licensed conveyancer may be) and if you need to borrow that money, then you’ll benefit from being familiar with banking practices, especially in relation to bank valuations and how they can affect you. Knowing what could happen means you can prepare yourself and give yourself the best opportunity to still achieve your goal to buy your desired property.