The Differences Between Tier 1, 2 and 3 Lending for the Commercial Lending Space in Australia

Understanding the Tier 2 and Tier 3 loan market. Which gives you more scope for growth in the Commercial Mortgage and Property Development financing sector?

Nathan Daly
May 21, 2020

The Differences Between Tier 1, 2 and 3 Lending for the Commercial Lending Space in Australia

Tier 1 - APRA regulated

Tier 1 loans, traditional mortgage-backed loans held by banks and regulated by the authorities, have been the go-to source for financing for generations. An application, some supporting documents showing income and expenses, tax returns, a balance sheet, and you have what’s needed for the banks to lock in an interest rate and draft the paperwork. For decades, the big four, Commonwealth Bank, Westpac, ANZ and NAB have been the obvious banking choices when shopping for a loan. They carry 75% of all Australia’s loans.

But what if you have sub-par credit, need a high LVR loan or the loan isn’t for a primary residence? For those looking for Commercial Mortgage Lending or Property Development Finance, the options have been pretty limited.

The recent “scandals” across Australia’s banking sector have made it difficult, if not impossible, to get a loan and that is especially true for commercial mortgages and speculative property development.

Across Australia’s banking system, the major players have all come under tighter scrutiny from the Australian Prudential Regulation Authority (APRA) after findings of unethical practices lending toward “profit at all costs” motives. They are now more regulated than ever. Bottom line for the consumer, this means more stringent adherence to rules and paperwork requirements and banks are declining more applications than ever to protect their own.

There are Options

The truth is, Tier 1 loans are highly rigid with set terms for repayment, interest rates, rules of subordination, not to mention all the documentation and patience one needs to secure one of these loans. But there are other options. There are Tier 2 and Tier 3 loans that may be more in line with what you want - and need.

No Frills Second Tier

Tier 2 - ASIC Regulated

Tier 2 lenders are like credit unions or building societies, meaning they source their own wholesale funding from sources other than customer deposits. In fact, many of them get their funds from the big banks. Tier 2 lenders are non-bank entities, and as such, are exempt from some of the more rigorous APRA rules imposed on banks. Not entirely loose to run amok on the financial plains of the wild west, Tier 2 lenders are regulated by the Australian Securities and Investments Commission (ASIC), whose primary goal is to protect consumers, investors and creditors while enforcing Australian finance laws. The APRA, however, does play an advisory role for the ASIC agency.

Free from the impediment of banking regulators, these lending institutions can offer the borrower more flexibility in loan terms, and they tend to be a little easier from which to secure a loan. If you do not fit neatly into the cookie-cutter loan types offered by the big banks, or if you have a less-than-stellar credit rating, Tier 2 lenders may be the solution you need.

Further, since they have fewer brick-and-mortar branch offices, their overhead is lower, and they can offer very competitive interest rates. They also tend to be a bit more flexible on the terms of the loan, allowing you to determine the term/interest rate and payment schedule.

Yet possibly most important, they are more flexible in their ability to grant loans. First, because they do not have to abide by all the rules and regulations that the big majors do. And secondly, because as lending institutions (opposed to banking institutions), their staff is more able to examine applications and use judgment to determine appropriate products for individual risk assessment.

The New Face of Private Lending

Tier 3 - Unregulated and P2P Lending

Gone are the days when you surreptitiously faced the nickel-plated, snub-nose-wielding gangsta in a smoke-filled room to secure a loan for a development project on the strip. People of means are looking for investment opportunities, and with the help of technology, online platforms now exist to bring investors and borrowers together in private, or peer-to-peer lending opportunities. All across the region, peer-to-peer (P2P) lending is spreading like vegemite, with Australia becoming the largest alternative (online) finance market in Asia-Pacific (excluding China), up 88% from 2017.

The beauty of the Tier 3 loan is that because the market is so competitive and has many players, both the borrower and lender can set parameters in accordance with their specific needs, risk tolerance, ROI goals, LVR limits, and more. With parameters in place, and a pool of hungry investors and borrowers, the platform is set and parties matched - in some cases, in real-time.

Getting the Tier 3 loan is often easier, too. Documentation requirements are much more flexible. If you need a no-doc or low-doc loan, you’ll do well to begin your search with the private sector as the lender is free to make decisions based on personal objectives.

Securing a P2P loan is almost always quicker as layers of middlemen and staunch bureaucracy are eliminated. Again, the lender does not have to conform to any regulations, oversight committees, nor do they need approval from a hierarchical system that could take days to pierce.

Tier 3 loans are perfect for SMEs experiencing cash-flow slumps from volatile or seasonal businesses. And they can often be had as IO (interest only) loans, ideal for short-term investments for Commercial Mortgage Lending or Property Development Financing.

In short, a Tier 3 can free up capital, give you greater control of fund distribution, and allow you to maximise tax deductions on interest payments. And they have a higher approval rate, once again, because of their flexible nature and because you’ve eliminated the middleman.

Interest rates will be determined by the lender’s credit history requirements, terms of the loan and loan assessment. For the most part, rates will be loan-specific and based upon the financial strength of the borrower and the investment risk. Other considerations are the loan purpose, size, and loan-to-valuation ratio (LVR). Rates can vary significantly from lender to lender, from platform to platform, and in some cases, may even be lower than that of a traditional bank.

Remember, when used properly, even a higher-interest-rate loan can still have its advantages.

So, what’s the best loan scheme for you? That’s a tough question to answer. Every case is different. Many factors play a role. But that is why Acumen Finance is here - to answer your questions, to personally evaluate your specific needs, to locate the best loan partner, and to help you plan a course of action. They will match you to the best type of loan for your situation and then match you with a lender who not only fits your needs but is actively looking for and pursuing borrowers just like you.

If you are interested in being an investor, contact Acumen Finance to begin the process.