Private Lending: What, How and Why.
Private lending is a growing segment of Australia’s financial landscape, providing a viable alternative for borrowers who may not meet the strict criteria of traditional banks. These loans are funded by private individuals or companies rather than traditional financial institutions, offering more flexible terms and faster access to funds. While private lending has its advantages, it also comes with specific risks and regulatory considerations under the National Consumer Credit Protection (NCCP) Act.
What is Private Lending?
Private lending involves loans issued by private individuals, companies, or investment funds as opposed to ‘warehouse funding’ where financial institutions such as AFG are funded by other financial institutions such as NAB. These lenders cater to borrowers who may struggle to secure loans from banks due to credit history, income verification, employment status, available timelines or the purpose of the loan. Common scenarios include short-term loans, bridging finance, property development funding, and business loans.
How Private Lending Works
Application Process Borrowers approach private lenders directly or via brokers. The application process is often simpler and faster than with traditional banks, focusing on the borrower’s asset position or project viability rather than their credit score. Private lenders generally can settle a loan within 1-2 weeks, with the majority of the time taken by property valuations. Some may settle within a day at a higher cost.
Loan Types
Secured Loans: Borrowers provide collateral, such as real estate or other assets, to secure the loan. The loan is focused on the available equity on property security taken and the loan can be secured via First & Second Mortgages, or caveats.
Unsecured Loans: These loans don’t require collateral but typically have higher interest rates to offset the increased risk. The expected rates generally start from 12% + and the only security taken are generally personal/director/business guarantees. The types taken generally depend on the loan amounts offered, with General Security Agreements taken generally at $200,000 + in the unsecured business loan segments.
Loan Terms and Interest Rates Private lenders often offer short-term loans, ranging from 6 to 24 months, with interest rates higher than those of traditional banks. Terms are negotiable, allowing for tailored solutions to meet specific borrower needs.
Repayment Structures Repayment options may include interest-only payments, lump sum repayments, or other flexible arrangements, depending on the agreement. These loans, if not arranged on an amortizing loan (principal & interest repayments), hinge on the ‘Exit Strategy’ (how the client will repay the loan in full at the end of the loan term). Examples include Sale of Property, Business, Refinance of the debt to a major bank etc. where the expected pay-out will clear all of the debt in full.
Risks of Private Lending
While private lending offers flexibility and accessibility, it’s crucial to understand the associated risks:
Higher Costs Private loans often carry higher interest rates and fees, making them a costly option if not repaid promptly. Expected terms vary depending on the mortgage taken (First or Second etc.), and arrangements (i.e. additional risk fees for no valuation with higher risk appetite lenders etc.). These generally look like:
Secured Loans
Establishment Fee: 1-3% of the loan amount
Legal Fees: $3,000 average and dependent on the lender
Valuation Fee: At Cost. Some lenders may charge an additional 2% risk fee if no valuation is performed due to urgent timelines etc.
Loan Amount: Most will offer 70% of the value of property security for residential metro property and 65% for commercial. This varies heavily depending on the lender and most focus on Eastern State properties. Lenders that offer higher loan amounts, will often charge a premium for it, making it significantly harder for a client to complete their intended exit strategy.
Unsecured business loans are more dependent on the business cashflow performance and health. Terms are generally 1-3 years, amortizing and charge 10-40% depending on credit score and conduct etc. Items such as missed payments and gambling transactions on business accounts affect a clients risk profile etc.
Shorter Loan Terms The short repayment periods can create financial strain if borrowers are unable to refinance or repay on time. In the event of a loan default, it is common for these lenders to swiftly take caveats over property security in preparation for repossession & charge default interest rates.
Limited Consumer Protections Secured private lenders will generally offer commercial loans only, hence the requirement for a corporate borrower and commercial use of funds. Commercial loans are not governed by legislation and is unregulated. Consumers lose significant protections, such as the requirement of providing a loan product that is in their best interests, or a clear dispute resolution process that is enforced by regulatory bodies, or clear penalties enforced by legislation that residential lending offers under the NCCP Act.
Default Risks In cases of default, borrowers risk losing the collateral provided, which is often their property or other valuable assets. Secured private lenders will also always take a General Security Agreement over the borrowing entity which allows lenders the rights to pursue unlimited damages in the event of a loan default such as lawyer fees etc.
Process Risks When dealing with the secured private lending segment, it is important to remember that:
The Terms are indicative only and subject to Lender’s credit approval and review by the Lender’s solicitors who will conduct due diligence on all legal aspects of the Security properties and the Facility. The lender has no obligation to issue a conditional or unconditional finance offer.
A valuation will generally be organised and the amount of lending made available potentially reduced if the valuation comes in below the estimated market value.
Lender commitment fees (where applicable and upfront, such as valuation and application fees) are non-refundable and payment may not result in any outcome.
Private loans are written over a short term between 12 and 36 months. Upon the expiry of this loan, you will have to repay the loan in full or refinance to a longer term bank solution. Through entering this loan you need to consider that a successful refinance is not guaranteed and there are risks involved which include the potential sale of your property at a future date
Is Private Lending Right for You?
Private lending can be a useful solution for borrowers needing quick or flexible finance, particularly for property or business purposes. They play a growing role in the lending market as bank lending policies tighten, and timelines to funding play a crucial role should a client be declined finance from other institutions etc.
However, it’s essential to:
Conduct thorough due diligence on the lender, especially on their default enforcement process. Not all lenders operate in a professional or reputable manner in this segment.
Understand all fees, terms, and conditions. Most lenders with a lower rate offering will generally charge the margins with higher establishment fees etc. It is important to consider all loan terms and conditions wholistically to ensure that the overall loan is more or less expensive.
Seek professional advice to assess the suitability and risks of private loans. Most secured private lenders will also require that you undertake independent legal advice to ensure that you understand the potential risks of the loan, especially if the matter becomes a future legal matter.
Private lending offers a flexible alternative to traditional financing in Australia, catering to borrowers who may not meet the criteria of mainstream banks. They play a strong role in segments such as SME construction where bank appetite currently exists with significant, experienced operators seeking corporate level debt only.
However, it’s vital to approach private loans with caution, considering the higher costs and risks involved. This segment carries the highest risk in the market and default will result in repossession of security assets, often with significant lawyer and default risk rate fees etc. As with any financial decision, careful planning and professional advice are key to making informed choices.
At Loan Central Hub, we are experienced navigators of this segment who can match you with the best loan product available from a panel of lenders who we have worked with historically in a consistent professional manner.
