Interest Rates Aren’t Everything

Smart investors and property developers know that there’s more to shopping for loans than finding low interest rates. Sometimes, you just need hard cash, fast.

Nathan Daly
October 16, 2020

Interest Rates Aren’t Everything

Unfortunately, when it comes to commercial mortgage lending and property development finance in Australia, it’s not so easy for businesses to acquire the capital that they need from traditional banks. The country’s quartet of major banks, known as the ‘Big Four’, have been subjected to increasingly stringent rules and regulations, as a repercussion for their mismanagement of the nation’s economy and fraudulent treatment of its population in recent years.

The Australian Prudential Regulation Authority’s (APRA) harder stance on the Tier 1 lending system, has caused the Big Four to be far less generous with their loans, putting companies and individuals through rigorous loan approval processes. As a result, small and medium-sized businesses are struggling to get the financial backing that they need to thrive.  

In light of the regulations and strain that they have put on Australian’s who need to access capital that, traditionally, only banks have provided, there has been a huge surge in the number of non-bank (Tier 2) and peer-to-peer (P2P), Tier 3 lenders. These new lenders are capitalising on the financial markets, plugging the void that Australia’s banking system is unwilling to cover.

When people are shopping for credit or loan providers, their eventual decision is usually based on the best interest rates offered at the time. But, in reality, Tier 2 and 3 lenders, with their higher interest rates, could actually be offering better deals when all aspects of the lending process are considered.

The Benefits of Tier 2 and Tier 3 Lending

Tier 2 Lending

The Tier 2 lending space is held by non-bank lenders who are regulated by the Australian Securities and Investments Commission (ASIC). These lenders, building societies and credit unions, for example, do not have a banking license, but they are Authorised Deposit-taking Institutions, authorised to carry out banking business in Australia by the Banking Act of 1959.

ASIC regulations are far less stringent than the ones that Tier 1 lenders are subjected to by APRA. This allows for far greater flexibility and fewer limitations on the number of consumers that Tier 2 lenders can offer loans to. This makes Tier 2 lenders an excellent alternative source of capital for SMBs that have been shunned by the Big Four and other Tier 1 institutions.

While Tier 2 lenders are considerably smaller in size, they compete with the Big Four with relative ease due to their business infrastructure. With far fewer physical resources, the operating-costs for the majority of non-banks are considerably less than Tier 1 banks. These minor differences have allowed Tier 2 lenders to widen their scope on the market and offer rates that are competitive, and sometimes better, than traditional banks.

Tier 3 Lending

In contrast, Tier 3 of the lending scale is an entirely private, unregulated P2P landscape. In this arena, both the lender and loanee are able to introduce their own parameters, like ROI (return on investment) goals, LVR (lending value ratio) limits and more, creating an agreement that best suits both parties.

Due to the unregulated nature of private-sector lending, there are far fewer hoops to jump through for loanees in the Tier 3 bubble, expediting the drawn-out process of Tier 1 lending. And, there is the added benefit that, at the discretion of the lender, terms can be far more flexible and accommodating of an individual’s needs.

In this market, loanees aren’t necessarily subjected to the traditional checks that banks would make. However, lenders will likely set interest rates that are loan-specific and based on the loanees financial strength. The measured risk of the investment will most likely play a key part, too.

On top of that, 3rd Tier lenders are ideal for short-term investments, as the majority of them offer interest-only loans, which are ideal if you’re in the market for commercial mortgage lending or property development finance. And, Tier 3 applications have higher loan approval rates than traditional banks, allowing SMBs to free up capital, giving business owners greater control over fund distribution and maximising tax deductions on scheduled interest payments.

What You Should Know About Short Term Loans

There are several loans available on the market. While non-banks and private P2P lenders cater to the majority of them, they also provide interest-only loans and bridging loans to the commercial sector.

Bridge Loans

A bridge loan is used to ‘bridge the gap’ while businesses process longer-term financial agreements, like the completion of commercial mortgage lending agreement. The bridging loan is a short-term loan with a term that can be as short as a few weeks ranging up to a year.

As bridge loans tend to be offered by private (Tier 3) lenders, they tend to have faster application processes, increased approval ratings, and faster capital release, making them an excellent way for businesses to access a quick injection of cash in times of need.

Be warned, though. These loans are always short term with high-interest rates and relatively large fees to cover the speedy processing of the loan. However, 3rd Tier lenders are fairly generous and usually give loanees an opportunity to escape the prolonged cost of accumulating interest on bridge loans by not including early repayment penalties.

Interest-Only Loans

Interest-only loans are excellent if a business is looking to purchase and renovate a commercial property. They offer lower repayments than standard mortgages for a set period ─ usually five years ─ which leave businesses with some money to play around with for their renovations. The period of low repayments also gives the business an opportunity to grow its cash flow before switching to the conventional interest rates set by the lender.

Alternatively, SMBs in the construction and property development industry that have been hit by the Big Four’s clampdown on commercial lending can use interest-only loans as a way of securing property development finance, to invest in their next property. The low repayment period gives the developer enough time to purchase a property, to renovate and, with any luck, sell it for profit ─ with which they can pay off the initial loan and keep what’s left.

However, interest-only commercial mortgages have one major drawback. When the lower repayment period ends, the monthly cost jumps up quite drastically, because the principal hasn’t been reduced.

The bottom line: as long as the income generated by your secured loan exceeds your expenses - including interest - an interest only loan will keep you in the black and give you the freedom and flexibility that only hard cash in hand can offer. Often, this is more lucrative than not closing the deal in the first place.

If you want to enhance your business capabilities and gain some much-needed capital to enable your aspirations, but you’re unsure which tier best suits your needs, why not get in touch with the specialists at Acumen Finance? We are a progressive, highly-experienced aggregator who will evaluate your needs and bridge the gap between your business and the best Tier 2 and 3 lending solutions.