What’s the trouble with caveat loans?

In this video Daniel provides a rundown on caveat loans and compares them with private mortgages across a number of elements, including servicing, up front fees, settlement speed and LVR.

Let’s find out more about this in the video below.

For an appointment with a Product Specialist call the office on 1300 652 158.

 

Hi everybody. I’m Daniel from AR Mortgages, and welcome to another Mortgage Monday. Today’s topic is the trouble with caveat loans. But what I’m really going to do today is I’m going to sneakily, or maybe not so sneakily, compare caveat loans to longer form private mortgage, which is exactly the product we offer.

So first off, the point I want hit here is:  What exactly is a caveat loan, and what exactly is a private mortgage? For those of you who don’t know, I’m going to run through it really quickly again.

A caveat loan really is a real quick settlement, short term,. It’s usually 60 to 90 days. There’s no ability usually to roll it. Interest is usually prepaid and capitalised into the loan, and it’s usually secured by either a first mortgage and these days a second mortgage. Once upon a time, years ago, we used to offer those types of facilities. We would secure it by an unregistered second and just have a caveat sitting on the property. These days, you really want to get registered, or most caveat lenders like to get registered prior to settlement. So they probably shouldn’t be called caveat loans anymore, but they still are. If you Google it, you’ll find a number of caveat lenders out there. But today I’m going to go through the arguments exactly why, if you can get a longer term private mortgage from someone like AR Mortgages, you probably should.

The next thing I want to talk about here is what exactly are private mortgages from our point of view. The only real difference from what we do and a caveat type loan is our loans usually run for a minimum of 12 months. They can be paid off early, and we do give a benefit back to the client if they pay it off early. But usually it’s 12 months. Interest is prepaid, very similarly in most cases to a caveat loan. Sometimes, if the client can show servicing, we’ll allow them to make interest payments. But generally, it’s very similar. The only difference here is the change in term.

So the next point I want to talk about here is servicing. How are these loans serviced? And the main difference between a caveat loan and a private mortgage, versus more traditional type of bank finance is it does really rely on the credit of the client and the servicing available to the lender.

So with a caveat loan, usually they’re serviced out of either a sale of the asset or refinance of the facility to a traditional bank lender, or some lumpy form of cash flow that’s going to come in at some point to pay down the loan. And that’s pretty similar to a private mortgage. So, in America, these types of mortgages are called hard money loans. The reason why they’re called hard money loans is because the money is hard to get from a traditional financer. And that’s really very similar to what we’re talking about here.

Moving right along, the next point here is up front fees. This is the bane of most introducers and clients’ issues with all types of products is paying up front fees. With caveat lenders, I know a lot of them, and I can’t speak for all of them, but most of them want hefty up front, non-refundable commitment fees even before they’ll have a look at the transaction. Now I know they have their reasons for doing that. At AR Mortgages, we don’t take up front fees before we make an offer. Generally, we want to inspect the property. We want to interview the borrower. We want to make sure that there’s a very, very high chance of us being able to settle the deal.

So if you’re going to a lender and they’re asking for heavy up front fees, you’re putting yourself at risk because if your deal doesn’t go ahead for whatever reason, and that usually swings around at the asset valuation, then you’re going to lose that money. So that’s one massive reason that if you can get a private mortgage loan from AR Mortgages, or someone similar to us, it’s best to go with a lower risk strategy where there’s not a high up front fee payable.

The next topic I want to talk about here is speed of settlement. With a caveat loan versus a private mortgage lender, such as us, there’s really no difference in the speed of settlement. A lot of the deals, we don’t require valuation up front. Some of the deals we do. But the reality is there’s no reason why the caveat loan should be able to settle any quicker than us. In fact, because we’re not sitting on a second mortgage, we don’t need to get priority and consents from first mortgagees, we can theoretically settle much, much quicker.

The next component is repayment strategy likelihood. When you get a loan from a hard money lender, a private mortgage lender, caveat lender, whatever you want to call it, you’re going to have to provide an exit strategy, and that is a way that the lender knows that you’re going to give him his money back at the end of the term. Often that repayment strategy is sale of the asset or refinance.

Now, from my experience, refinances are not really done until the money is in the account and the loan is discharged. So it’s really difficult to bank on that. If you’re only giving yourself 90 days to get a refinance, you’re putting yourself at high amounts of risk because it’s just not enough time in this market. Should something go wrong, you have to apply to another lender, to give you enough breathing space.

The same goes for the sale of the asset. If you’re selling a property and you’re giving yourself 90 days, you’re kidding yourself, because it can take 6 to 12 months to sell a commercial, really any type of property, and get a reasonably good price for it and not have to sell under forced conditions.

So you really need to consider and match your term of your loan with exactly when that money is realistically going to come in and to give yourself enough flexibility there. So in that instance, the 12 month private mortgage loan is a lot more beneficial, and it’s a lot more realistic facility to have, given the outcome, or given the repayment strategy likelihood.

The next topic here is LVR, and what that means is loan to value ratio. That’s the amount of money that the lender will advance you against a security. So, with AR Mortgages, we generally only go to 60% to 65% of a standard commercial or residential type of property. We like to keep it lower than that.

With caveat loans, one feature where they do seem to stand out is that they say that they’ll go to 70%, maybe even 80% of the value of the property, and that could even be on a second mortgage. The issue we have here is:  What is the value that they’re giving to that property? We like to give a realistic value to the property, what it’s going to sell for under reasonable sale conditions. What a caveat lender will tend to do is look at the forced sale of the property. There’s nothing wrong with doing that, because they’re saying, “Well, the value of the property is really only what we’re going to get for it, should we have to sell it.” When they sell it, it’s going to be under forced conditions. So really they can cut back the LVR on their loan a bit. It’s something to think about. It’s something to ask your lender before you go ahead and put the money in the bank to get the valuation done. But that could be, if it’s a true 80%, it is one advantage that a caveat loan has over a loan from someone like us that runs for 12 months.

Let’s hit the last couple of points here. Term versus exit strategy, we’ve sort of covered that already, so I’ll skip through to flexibility. When you’ve got flexibility in your facility, what I mean by that is, although our loans are 12 months, we always give a repayment discount. So that means that if you’ve got a 12 month facility and you want to pay it off in 3 months or 90 days, you can. Sure there’ll be a bit of a penalty to do it or prepayment fee, but you still have that flexibility to match the caveat loan for 90 days. But if you need it to run for more than 90 days, you can. You can run it for 12 months. So, as a good business person, what you really want to do is give yourself that flexibility and cover off the worst case scenarios, and that means giving yourself as much breathing space as possible.

Now there’s one point I haven’t put on the board here, and that is to talk about pricing. I know I don’t need to say this to most people, but when you compare the costs of a caveat loan, generally they’re going to be a lot more expensive than a longer term private mortgage. I can’t say that’s the case in every situation, but generally that is case, and obviously you’re going to want to go for the cheapest option that suits your particular circumstances.

So, as a good business person, like I said, you really want to hope for the best and plan for the worst. So on that note, I’m going to leave you. If you’d like an appointment with a product specialist, give us a call on the 1300 number. Subscribe to our YouTube channel and like us on Facebook. Thanks for watching.