Appealing to the Lender: Exit Strategies and Collateral
In Australia’s regulated financing market, applicants need to appeal to lenders with solid exit strategies and creative collateral ideas.
Appealing to the Lender: Exit Strategies and Collateral
Real estate has always been a solid investment market. As such, over 66% of Australians either own a home outright or are making mortgage payments toward one. But many Australians are starting to realise that real estate investments can be more lucrative, especially in the growing commercial mortgage or project development sectors. Some of these investors are even borrowing on primary-home equity and SMSFs to do so.
If you are ready to make your venture into direct first mortgage investments to make your money work as hard as you do, you may find yourself needing a loan to realise these ambitions. However, finding a lender who is willing to help you may be a bit tricky. Traditional banks are declining more applications than ever. There are alternative funding sources, however, like private/P2P lending. To venture into this new Fintech opportunity, it’s best to have a trusted and knowledgeable partner such as Acumen Finance. Contact us about our property development finance opportunities.
Appealing to the Lender
Regardless of whether your lender’s address is a postcode or the Internet, when you approach a lender with your proposal, it is vital that you have a sound financial model for your investment plans – including an exit strategy.
Exit strategies can soothe investor concerns by demonstrating that you have a concrete plan to service the loan within established terms and by providing contingency plans when needed. Incorporated into the application, they also instil borrower motivation.
So what are the most common exit strategies? Here we look at four common exit strategies and look at some out-of-the-box ways to secure your loan and present an appealing loan package.
Four Common Exit Strategies
Sell the property. If you are buying property as an investment, you may be considering a hard-cash loan (See our description of tier 2 or tier 3 loans). Most hard-cash loans are short-term loans. They are pertinent to those who are developing or rehabilitating commercial and/or residential properties. The property that you are borrowing against (collateral) is sold after completion. The lender collects principal and interest and the borrower receives the capital gains.
Refinancing to a traditional loan. In this strategy, the borrower moves the loan from a short-term to a long-term position. This is particularly helpful for investors who are able to improve credit history during the original loan period. It is also ideal for those investing in a long-term hold property (primary residence or rental property) that requires renovations before traditional financing becomes available.
Refinancing to subprime loan. Not everything in life goes as planned. Therefore, refinancing to a subprime loan may be a “Plan-B” solution for those who were not able to meet the criteria for traditional lending, such as failing to repair credit history or increase income as expected. While the interest rates may still be higher than that from a conventional bank, it is a viable long-term position for those with few choices. In many cases, you may be able to settle early without penalties. Be sure to check the terms of your agreement and prepare for this scenario.
Sell other assets. Assets can be almost anything of value that the lender is willing to hold as collateral. Equipment, real estate, accounts receivable, inventory are common assets, as are vehicles, artwork, precious metals, and gems. (Read on to see more about collateral and how it can be used to appeal to lenders.)
Refinance (or extend) to another hard-money, short-term loan. This should be taken as a last resort and only if you are sure that your “new” exit strategy will hold. If you have made all your payments as promised, the original lender may consider granting an extension – for a fee, of course. In this situation, you should probably reevaluate your goals and redraft a new timeline. Be prepared to demonstrate that the extension is justified, especially if you are dealing with the same lender.
Just as an impenetrable exit strategy will appeal to lenders’ risk tolerance, so too will collateral assets. The key is that the asset should be of significant value, maintain its value, and be reasonably easy to liquidate. Assets can be written into the terms of your contract as exit strategy contingencies or used independently to increase the LVR, negotiate the term of the loan, or to make your investment proposition unique.
We love this category because as a provider of private loans, we have the flexibility and freedom to consider almost any asset of value for collateral - subject to the participants in our lending pools, of course. Historically, there have been some pretty creative “assets” accepted by other lenders. Assets as unconventional as wheels of parmesan cheese, wine, and even racehorses have been deemed as worthy collateral. While not every lender is of the “wine, cheese and livestock” variety, this just gives an example of how creative and flexible a private lender can be - if they so choose.
More common assets that can be written into loan terms are a Joint Venture agreement, equity position on a property title (caveat loan), or even a seat at the board of directors.
In addition, traditional lending elements are commonly used to entice lenders. You can offer points - an up-front fee, or exit fees paid at the completion of loan servicing. These fees are typically based on the loan amount.
Private Lending Flexibility
When borrowing from a private lender you are borrowing hard cash, meaning that once approved, you will be given funds that you can manage to pay overhead expenses, contractors, property managers, etc. In addition, borrowing from a private lender is usually much easier: less paperwork (which is especially good for non-conforming loans); faster, the typical turnaround from submitted application is 7 to 14 days and can be much faster when necessary; and flexibility, private lenders can consider candidates with a higher LVR and sub-par credit histories. When venturing into the real-estate-as-investment market, most borrowers will face at least one of these issues. In return for the flexibility (and creativity), you may expect to pay a bit more on interest rates, but, as we highlight in our Interest Rates Aren’t Everything article, sometimes the added expense is well worth it.
These types of contracts and underwriting negotiations are clearly best left to the professionals - people with knowledge and experience. We at Acumen Finance, are a lending partner who understands the mechanics of the transaction and can ensure that the formatting of application and credit documents meet the standards that you would expect from a Big Four bank lender. Contact us to speak with our expert team and start your loan application today.