2nd July 2008
Risks in Private Lending and how La Trobe manages them
Arranged properly, private lending is an investment choice for investors seeking a higher monthly income from an investment in mortgages. However, as with any form of investment, there are risks that need to be understood.
In this newsletter we concentrate on three key areas of credit acceptance, how they relate to investor risk and how La Trobe manages these risks.
The three (3) key 'Cs' of credit are:
- Capacity; and
In assessing an application for mortgage finance, La Trobe looks to the character of the borrower to verify that the borrower is likely to service the loan and then repay it on maturity. The risk in this area of credit acceptance is that the borrower does not have the appropriate 'character' to support a decision to grant the borrower credit.
The character of a borrower can be ascertained by looking at their credit history, residential stability, employment history and asset accumulation.
La Trobe's Policy
La Trobe's Application for Mortgage Finance requires the borrowers and guarantors to complete a declaration as to whether they:
- have been declared bankrupt, insolvent or entered into an arrangement for the benefit of creditors;
- have been refused credit in respect of the current application previously;
- have had any court judgements entered against them or if they have defaulted on any loans; and
- have been (or are) a shareholder or officer of a company where a manager, receiver or liquidator has been appointed or whether any court actions against the company had been taken.
In addition to this declaration, La Trobe further investigates the 'credit worthiness' and 'character' of borrowers by conducting a credit check and obtaining an independent credit report through a credit reporting agency. This credit report can provide up to five (5) years' history of credit enquiries made by the borrower including any defaults, court actions or bankruptcy actions taken against the borrower.
La Trobe's Application for Mortgage Finance also requires the borrower to provide details of their:
- Type and length of employment;
- Current residential address and length of residency; and
- Current assets & liabilities.
La Trobe is conscious that credit fraud or deceptive conduct may occur and has embraced the requirements of the Federal Government's Anti-Money Laundering legislation and 'Know Your Customer' requirements for customer identification. All mortgage documents for new loans are prepared by La Trobe's panel of independent solicitors who also undertake all necessary property searches and carry an appropriate level of fidelity and professional indemnity insurance.
The borrower must have the 'capacity' to service the loan throughout its term, and this means making the required interest payments on time and in full. The risk here is that the borrower cannot service the loan, and that the borrower will fall into arrears during the term of the loan.
La Trobe's Policy
To manage this risk, we check the capacity of a borrower to service the loan by looking at their income, length of employment and servicing ability.
We always assess the capacity of the borrower to service the loan commitments. Depending on the individual circumstances - whether the borrower is self employed, PAYG or a company, we ask the borrower to provide a repayment certification and a letter from the borrower's accountant confirming the borrower's repayment ability or a letter or pay slips from their employer. These details are then assessed using La Trobe's Net Disposable Income ('NDI') calculator. ABN and White Pages searches and telephone interviews are also conducted on all employers and accountants to ascertain their legitimacy.
If a borrower defaults on their repayments, we implement a strict recovery procedure. As soon as a payment is not made, the borrower is contacted and payment is sought. Should the payment not be brought up to date, or a suitable arrangement entered into, the procedure to take possession and sell the property will commence.
The ultimate protection for investors in a private loan is the registered mortgage over the security property.
The 'collateral' offered by the borrower can be ascertained by looking at the security property to be taken and if any guarantees are required. The cornerstone to prudent private lending is the establishment of the value of the property and then setting the appropriate loan to valuation ratio ('LVR').
La Trobe's Policy
La Trobe only obtains valuations from registered valuers who are on La Trobe's panel of approved valuers and who have the appropriate Professional Indemnity Insurance cover. A valuation report must be provided for all non residential securities and the majority of residential securities. In certain circumstances where the security is residential or rural-residential and the amount of the loan is 40% or less than the value disclosed in the most recent Municipal Rate notice of the land and any improvements, a valuation report may not be sought.
The LVR applied depends on the type of security property being taken. The LVR will not exceed 80% unless the loan is for a Special Situation mortgage. Special use properties and rural properties have a reduced LVR reflecting the type of security.
As part of La Trobe's lending practice and administration policy, we ensure that all security properties with improvements have the appropriate level of property and fire insurance.
Where a loan is provided to a company borrower or where the borrowers and mortgagors differ, La Trobe obtains guarantees from the appropriate parties.
As with all types of investments, there are associated risks, and recognising those risks and managing them appropriately is the key to successful investing.
At La Trobe, we consider that we have a range of risk management strategies that ensure that the risks of private lending are kept to a minimum.