The other side of Lending – Mortgage Schemes

Investing in a mortgage scheme
“I wish to get a better rate of return on my money and don’t really mind having an indirect exposure to property as the underlying asset class.'

That's roughly how a mortgage scheme (also called mortgage funds) works, except it involves three extra features: 

1. More than one person contributes money to the scheme;
2. Investors' money is pooled together or used in a common enterprise for scheme members; and
3. Scheme members give up day to day control over how the scheme operates.

Like any investment, you face risks. Your returns will be affected by the ups and downs of property values and interest rates. You also rely on the skill and honesty of scheme managers and property valuers to find borrowers who can pay on time, with adequate security.

In the past, most mortgage funds have operated successfully. Some, regrettably, got into disastrous financial trouble; either because the managers lacked the skill to manage mortgages, especially when some of the borrowers failed to pay, or they lent too much money on optimistic valuations or risky development properties. A handful of operators defrauded investors.

Watch your margin of safety
Risk in mortgage lending lies in the gap between the value of the property and how much of that value is being lent to the borrower (described as the loan-to-valuation ratio). The closer the amount lent to the value of the property, the higher the risk that you might lose part of your investment. A $60,000 loan for a property valued at $100,000 represents a conservative 60% loan-to-valuation ratio, but a $95,000 loan on the same property represents a much riskier 95% loan-to-valuation ratio.

What type of scheme can you choose?
Mortgage schemes, or mortgage funds can be set up in different ways. You can choose:

• Pooled mortgages, where all investors share in all the mortgages. You therefore take your share in all the income and spread the risks across all the mortgages that the scheme manages. LOW / MEDIUM RISK
• Contributory mortgages, where you choose which mortgage(s) you invest in. Your mortgage(s) may pay a different income from other mortgages in the scheme. Your risk depends on the quality of the borrowers to whom you have chosen to lend. MEDIUM RISK
• Debenture or mortgage companies, where you invest in shares or debentures issued by a company that invests in mortgages. Here, you are really becoming a shareholder in, or lender to, the company, which in turn owns the mortgages. Check whether the mortgages are pooled or linked to specific properties. HIGH RISK.

What type of scheme managers can you choose?
All scheme operators must treat investors honestly. At present you will find these types of scheme managers:

• Managers of registered schemes must operate the scheme through a public company that holds an Australian Financial Services Licence and comes under ASIC regulation. (You can check this licence free of charge through the ASIC website or contact the ASIC Infoline by email infoline@asic.gov.au or ring 1300 300 630.) The scheme must have a constitution, a compliance plan and a product disclosure statement that you can inspect. It must also have proper internal procedures for handling complaints, and be a member of an authorised external dispute resolutions scheme.
• Managers of industry supervised schemes must be supervised either by the Law Society of NSW or the Law Institute of Victoria. First, get a copy of the rules set by each body, then make sure any scheme you are considering is abiding by the rules before you invest.
• Directors of mortgage debenture companies must operate through a public company. They must act honestly and diligently, but require no licences or complaints schemes. The directors are free to choose whatever operating systems they like so long as they obey general company law.
• Managers of unregistered and unlicensed schemes must restrict their scheme to 20 people or less and must not be in the business of promoting schemes. Unregistered schemes are not regulated by anybody. You are on your own. Check everything and everybody involved.

What should you choose?
Mortgage schemes may suit your needs and circumstances. Choose the scheme and the manager that suits your own knowledge and experience. If you possess no expertise in this area, you should seek appropriate financial advice.

For more information about mortgage schemes and whether they suit your needs, speak to one of the financial planners at Intellichoice today on +61 7 3624 1900 or email info@intellichoice.com.au. Alternatively, visit www.intellichoice.com.au.