A loan must always be capitalized above the Liquidation Threshold, i.e., Collateral Value * LVR. Loans that fall below the Liquidation Threshold may be subject to liquidation. Liquidators repay the loan and receive a greater portion of the position's collateral in return. A liquidation event incurs a Liquidator Fee, which varies for each collateral type.
As an example, say a Borrower supplies $1000 worth of collateral which has an LVR of 60% and a Liquidator Fee of 15%.
At that moment, the collateral is able to collateralize up to a $600 loan. Let’s say the Borrower takes out a loan of $500 USDC. Their loan position’s Health Factor is $600/$500 = 1.2. A Health Factor greater or equal to 1 is above the Liquidation Threshold and is safe from liquidation.
If, because of a downward movement in the price of the collateral, the Total Collateral Value falls to $800. The maximum amount that collateral can guarantee is now $480. The loan position’s Health Factor is $480/$500 = 0.96. The position is subject to liquidation.
The liquidator pays out the loan (500 USDC) and, in return, receives collateral to the value of the loan plus the Liquidator Fee of 15%. i.e. 115% * $500 = $575.
This leaves the Borrower with $225 in collateral value.