Question

A property that was valued at $750,000 three years ago is being held as security for a loan. The bank's policy is to lend at a loan-to-value ratio (LVR) of no more than 75%. If the current loan outstanding is $487,500 and a recession occurs reducing the value of the property to $610,000;

a) How much money is the borrower required to pay to remain compliant with the bank's policy?
b) If the bank prefers to accept additional collateral security instead of a payment, what is the minimum value of the security that the borrower must present to the bank to remain compliant with the bank's policy?

Answer 1

The borrower is required to pay $30,000 to remain compliant with the bank's LVR policy due to a reduction in property value. If the borrower chooses to provide additional collateral instead, it must be valued at a minimum of $40,000.

Step-by-step explanation:

Calculating the Required Payment and Additional Collateral

To remain compliant with the bank's loan-to-value ratio (LVR) policy, we first need to calculate the maximum allowed loan based on the property's current value. With an LVR of 75%, the maximum loan amount for a property valued at $610,000 is 0.75 * $610,000 = $457,500. Since the current loan outstanding is $487,500, the borrower must pay the difference to remain compliant, which is $487,500 - $457,500 = $30,000.

If the borrower opts to provide additional collateral instead of making a payment, we need to calculate the amount of additional security required. The bank would need the total value of security (current property value + additional collateral) to support the current loan amount at the 75% LVR. Therefore, the required total value of security is $487,500 / 0.75 = $650,000. Given the current property value is $610,000, the borrower must provide additional collateral valued at $650,000 - $610,000 = $40,000.