How leverage works in real life

By Aidan Devine | 02 Aug 2012

Ever been curious? We unveil the mystery and show you exactly how much the bank will own after you’ve refinanced


Consider an example where a would-be investor (Danni) has a property currently valued at $300,000 with a $120,000 loan (therefore $180,000 in borrowable equity). Danni wants to buy an investment property for $350,000 but she doesn’t have a cash deposit. 

Borrowable equity= $300,000 x80%- $120,000=$120,000

Investment property=$350,000

In this instance, the bank will add the total loan amount that Danni requires over the total security she will have. 

So Danni’s total loan will be her $120,000 existing mortgage plus $380,000 for the purchase price ($350,000 and $30,000 for costs) of the investment property (of course we would split these loans out to avoid cross-securitisation but for the sake of simplicity, let’s ignore this for a moment). In other words, Danni’s borrowing more than the total cost of his new investment property and increasing her overall borrowing to $500,000. 

New borrowing= Existing loan + Investment property value + cost

New borrowing= $120,000 + $350,000 + 30,000= $500,000

Loan to value against investment property= total borrowing/property value x100

New loan to value ratio=$380,000/$350,000=109%

At the same time, the total value of the property the bank will be holding as security is $650,000 (Danni’s home worth $300,000 and the investment property worth $350,000). Therefore, the LVR is calculated by dividing $500,000 (total borrowings) by $650,000 (total security), making Danni’s total LVR just under 77%. 

Total security held by the bank= existing property + new investment property

Total security held by the bank= $300,000 + $350,000= $650,000

Total loan to value ratio= total borrowing/total security x100%

Total loan to value ratio=$500,000/$650,000=77%

So although Danni has borrowed 109% of the new investment property’s value (being the price plus costs), the equity in her existing home reduces her overall LVR and provides the bank with ample security.

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