HOW CAN A PRIVATE MORTGAGE MARKET EXIST? WHY DON’T BANKS COMPETE?
“A bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain” — Robert Frost
When we first introduce people to private mortgage investments, a common question is “Why do people borrow money privately, rather than from institutions such as banks?” There are a number of good reasons. In the main, the problems borrowers experience in attempting to deal with banks ensure the continued existence of the Private Mortgage Market.
- Banks Can Be S-L-O-W. A private lender can give quick approval. Often the bigger the organisation, the slower the response. There are many reasons why borrowers may need money quickly. Often they are obliged to settle promptly on purchase of property or a business. They believe they have bought very well, so may be prepared to pay a little extra interest to secure the deal. We have seen borrowers lose three weeks waiting for a bank verdict, then with deadlines looming, turn to the private market just to get efficient approval.
- Some Borrowers Hate Banks &/or Find Them Intimidating. When times are tough the banks are often seen as the ‘greedy villain’ or at the very least, insensitive. People who have suffered unfortunate experiences at the hands of a bureaucratic bank typically exhibit avoidance behaviour, or stay clear of banks on principle.
- Rigid Bank Policies. Nowadays, bank loan approval has become a centralised back-office process reduced to a form filling exercise, capable of administration by clerks. If the form is rejected by the computer there is little scope for appeal. Local branch managers don’t stay in one place long enough to get to know the customers, and don’t have the discretionary powers they used to have. We have seen quite robust lending proposals approved by a WA based bank executive, then blocked by Eastern States management who don’t have local knowledge.
Private lenders and their advisers make an informed judgement based on the overall merits of a case which the banks might reject on a technicality. For business loans banks often insist on taking security over the business as well as the real estate, and demand six-monthly cash flow updates whether or not interest is being paid in a timely fashion. We have seen banks refuse loans for new businesses until two years’ trading results are available: even though the borrowers have good credit ratings, years of business management experience and quality property as security! In such situations borrowers seek a two year private mortgage loan, then refinance with a bank.
- Bank Interest May Not Be Cheaper. Banks have a two-tiered interest rate structure; concessional rates for home lending, and significantly higher rates for business and investment purposes. This partly reflects the fact that personal housing loan interest is not tax-deductible, while business loan interest is deductible. Most private mortgages finance business or investment, and the interest rate is no more than the bank would charge.4. Banks May Require Interest & Principal Repayments. Private lenders prefer interest-only and so do many business borrowers. Interest-only repayments are more tax effective for the borrower and easier on cash flow. From the lender’s point of view, interest-only is simpler as well as being a budgetary aid – lenders are prepared to spend interest income on living expenses, but wish to preserve their capital intact, so don’t appreciate small part-capital repayments.
- Banks Avoid Lending to Overseas Residents. Well-to-do Asians will often finance W.A. property acquisitions on the private mortgage market.
- Banks Invade Privacy. Some wealthy investors have business interests which are many and varied. The banks want all the details, however time consuming and expensive it may be to collate this information. Private mortgagees are usually prepared to lend on a commonsense basis i.e. they make certain they hold good security, but are not quite as demanding of details.
- Borrowers Experience Inertia. Once mortgagors have had a good experience in obtaining funding through private sources, they are more likely to continue that habit pattern. We know of a number of people who buy, sell and develop real estate, who would probably qualify by bank criteria, but who voluntarily remain in the private market.
- Borrowers Remain Uninformed. Sometimes borrowers can get a better deal at a bank. They just don’t know it. They deal with the most convenient source of finance they happen to find.
- In the past 25 years the Big Four Bank oligopoly has doubled its presence in lending markets, from 40% to 80%. This, and sometimes overzealous regulation by APRA and ASIC has lead to the inevitable reduction in competition.
- The existence of a soundly based private mortgage market is a boon to investors, who get tangible security, predictable returns and attractive interest rates. It is rare indeed in the world of investing to find comparable returns backed by assets which can exceed the invested amount by 50% and more..
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Chris Blake AMFAA
Australian Credit Representative 395833
M: 0418 911642