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In the world of finance, property-secured bridging loans such as Caveat or Second Mortgages are much maligned. But using the equity in one’s own property to raise cash for an urgent matter is every Australian’s inalienable right. What borrowers and brokers need to know is how lenders consider risk and set costs accordingly.

 

A ‘Caveat Mortgage’ differs from a ‘Registered Mortgage’ because it is an unregistered interest. It is lodged with the Land Titles Office to serve as a warning to all interested parties that there exists an unregistered interest in the property. An unregistered mortgage differs from a registered mortgage because it is not a charge on the land. It relies simply on a promise by the borrower to reserve sufficient equity in the property to repay the lender when the property is sold.

 

Caveat Mortgages exist because some borrowers, and some brokers to that matter, push lenders to lend quickly. Frankly this simply causes the borrower to incur costs that could easily have been reduced if the lender had taken a couple more days to arrange matters to reduce risk. And risk is everything to a lender. The level of risk determines the price to the borrower and the faster a lender is asked to go, the riskier the deal.

 

Registered mortgages enjoy the benefits of indefeasibility. ‘Indefeasibility’ is an interesting piece of legislation that protects registered mortgagees from fraud. A registered mortgagee who is induced to lend against real property by an act of fraud, and who is found to have had no knowledge of the deception, will not see the mortgage set aside. It’s an important lesson for any land owner to be sure to protect their Certificates of Title from abuse. If someone manages to mortgage your property, you will find the lender forcing the claim on you.

 

Caveat Mortgages do not enjoy the protection of indefeasibility so in this respect they carry higher risk and borrowers who push for speed are more likely to be hiding something.

 

Caveat Lenders are, more often than not, asked to provide funds as a subsequent lender to an existing prior mortgagee. And registered Mortgages always have priority over Caveats. From a lender’s point of view this is significant.

 

All lenders and brokers understand the importance of LVR (Loan to Value Ratio). It is all-important in deciding the amount of equity, the amount of protection afforded to the lender in the event of default. So protecting a Lender’s rights to that equity is what truly defines risk in property lending.

 

Where a property secures more than one mortgage the law applies a ranking to them. A First Mortgage has first ranking, a Second ranks behind a first and so on. Caveats are not registered and they always rank behind registered mortgages. The general rule is that if there is more than one Caveat, then it is the Caveat lodged first in time that ranks ahead of the others.

 

The cost of interest on a loan in a competitive efficient marketplace is determined by risk and loss. An efficient Lender who prices risk accurately to potential loss, and who sustains low levels of loss, is able to make sufficient margin for profitability but also compete for a larger envelope of risk.

 

Caveat lenders who cater to the need for speed, will always be more expensive than those allowed to take the steps necessary to protect their right to equity in the event of default. A Caveat provider who does not have time to serve a Notice of Priority on prior lenders, to protect his standing in the line to collect in the event of default, could easily lose if, for example, a prior lender increased the value of an existing loan to the borrower, thereby erasing the portion of equity the Caveat provider was relying on as leverage to ensure repayment.

 

Also, Caveat providers who do not have time, or take time, to properly value a property, must also charge a premium for risk because they will suffer higher losses than those who do.

 

Most Caveat providers restrict lending to business or investment use. This is because the preconditions that determine a loan as being ‘for business or investment use,’ are also the conditions under which the lender is best protected from having an interest set aside. That is to say, if a lender identifies a genuine business or investment use, and a genuine ability to repay, on a property other than a borrower’s primary residence, then a Court is more likely to uphold the debt than in cases where the opposite is true.

 

The most important thing is to be sure the borrower has the capacity to repay, and is using the funds for a purpose for which the cost of doing so is reasonable.

 

If a borrower proclaims a desperate need for funds it is because they wish to take advantage of an opportunity, or because they are in desperate states. It is important to know which.

 

If a borrower wishes to take advantage of an immediate opportunity then they will have documentation to back this up and a Caveat may be appropriate. Their documentation will provide the lender the security needed to safeguard against loss and the price will reflect this.

 

If a borrower is in a desperate financial state and planning to sell an asset or remortgage an asset then again, a Caveat Mortgage may be helpful. But deal with a Lender who can appraise the deal quickly and provide an Offer Letter, but who will take the two days extra to achieve a Notice of Priority and proper valuation. The Offer Letter will help the lender stay action by nervous creditors, and taking time to achieve Priority and a proper valuation will reduce the cost of the loan to the client.

 

If the aim of a borrower seeking a Caveat Mortgage is to refinance, be sure they have the finance in place first, so the loan period of the Caveat Mortgage is kept to a minimum. And if they do not have re-finance in place, brokers should do their due diligence on borrowers to be sure they can place the mortgage. If this is not done, the Caveat provider should be doing it anyway and without a solid exit, should not proceed.

 

No one should encourage desperate people to take desperate measures. Encouraging a borrower into an expensive Caveat, only to see their exit strategy fail, will be disastrous for them. And it may well be that the broker has aided and abetted an unconscionable loan.