At Development Ready, we get asked a lot about how to finance property development and the different types of lending options available. To help answer these questions, we’ve put together this article that summarises the main types of lenders and the key differences between them.
The first thing to note is that borrowing for development is very different from borrowing for investment. Financing property development is considered riskier for lenders and their requirements are, therefore, more stringent. However, there are hundreds of financial institutions in Australia with lending packages to choose from.
Blue Chip Finance Options: The Big Four Banks
Because of their size and scale, there’s something trustworthy and reliable about acquiring finance from one of the big banks. Perhaps it’s the rationale that they’re big for a reason, that they must have good customer service, fair rates, safety and stability and security to have achieved their success in Australia.
And certainly, the big four banks – Commonwealth Bank, Westpac, ANZ & NAB – dominate the lending market; it is believed that they support 85% of the Australian home loan market.
The fact is that the big banks can offer you attractive rates and, oftentimes, a simple, secure process for application. However, due to their volume, the big banks are likely to be more stringent than second tier lenders and you may find yourself rebuffed.
This may not come as a surprise but customer satisfaction surveys also show smaller lenders receiving a much higher customer service score, 92.65%, compared the big four’s 80.3%.
No matter how big, Australia’s financial institutions - banks, credit unions, insurance, superannuation companies and the like – are all classified as an ADI (Authorised Deposit-taking Institution), meaning they have to adhere to the rulebook set by the government overseer APRA, the Australian Prudential Regulation Agency.
APRA’s control over the big four banks has led to more frequent changes and a faster paced market. As a result, mortgage brokers and consumers alike have had to spend more time researching the varying loan offerings.
In 2015, APRA restricted the ratio of investment loans, which triggered the increase of interest rates and tightening of loans by the big 4, in their attempt to curb growth. This decision may have left shareholders happy but many customers were left with higher mortgage repayments or high and dry by the major banks.
Since then, more property developers and investors have opted to pursue second-tier loans…
Second Tier Lenders: 4 Things to Know
Second tier lenders (or non-bank lenders) are lenders who don’t hold a banking license. They could be a building society or credit union, which just means they find their own wholesale funding from other sources. Many of them will secure their funds from the big banks themselves. For example, Rams is a non-bank lender but in fact it’s owned by Westpac.
Small Lenders = Less Overheads, Better Value
Second tier lenders can offer greater flexibility, which is certainly an element to consider when weighing up the pros and cons of a second-tier loan.
Part of the reason is infrastructure, or lack thereof. Unlike the big 4, who operate costly bank branches nationwide, a second-tier lender will usually provide online or phone services as a replacement.
By keeping overhead costs down, the theory is that these institutions can pass this saving onto you, sometimes at even lower rates than the big 4. There isn’t a massive downside to low overhead costs (aside from convenience), especially if you’re going through a mortgage broker who’ll manage the process for you.
Can second tier lender interest rates compete?
To state the obvious, it pays to do your research. There is no definitive answer to this, suffice to say that second tier lenders have to offer competitive rates. How else can they compete against the big banks?
And while you are conducting your research, make sure you consider another key factor: exit fees and upfront costs. Some second-tier lenders offer really attractive mortgage interest rates but higher exit fees (sometimes as high as 1 or 2% of the original loan amount) or higher upfront fees. Make sure you read the fine print and do the right calculations.
A lot of people assume that smaller lenders will not be as safe as the big banks. However, all financial institutions in Australia are regulated by independent government bodies. This levels the playing field and stops, for example, a predatory second tier lender from accepting any loan proposal that comes their way.
Having said that, second tier lenders are still a viable alternative if you’re not best placed to go down the traditional path. Roughly a quarter of Australian borrowers have their loan applications rejected by the major banks for many reasons…bad credit ratings, self-employment uncertainty and age to name a few.
The good news is that second-tier lenders may be more open to proposals so you stand a better chance of being approved, even if all four major banks have raised concerns.
For those denied by the major banks, it is heartening to see second-tier lenders becoming more efficient at keeping interest rates low across the board. Just be aware that they may charge a higher premium (usually between 1-5%) should your application raise some red flags.
It is definitely worth researching alternatives to major banks, just as it’s important to consider the different types of loan. We hope this article has helped you learn the difference between blue chip and second tier lenders so you can make informed decisions moving forward. But if you’re still unsure or if you’d like an expert opinion, speak with the professional property team at Development Ready.