What are mortgage funds?
What are mortgage funds?Mortgage fund investments are a type of managed investment where investors’ funds are lent to a borrower in the form of a mortgage. The borrower pays interest which is passed on to the investor.
There are typically two ways investors can go about it. Either in pooled or stand-alone managed fund trust structures.
Pooled funds
As the name suggests with a pooled fund your money is put in a large fund and spread across many investments.
When you invest in a pooled mortgage fund, your money is exposed to a range of loans. You then receive the average interest from all the loans, less the management fees.
Contributory funds
Also called select funds, direct funds or stand-alone funds, this type of mortgage fund is structured so your investment is made into an individual loan. The investor pairs up with a private, non-bank lender who provides the mortgage. This is usually done at rates higher than traditional bank loans.
How do mortgage investors make money?
As is usually the case, pooled funds are lent out to multiple borrowers. At APG, we usually have up to 30 active loans in our portfolio at any given time.
The advantage of this setup is that there is diversity in the investment which is vital in managing risk.
Investors receive regular distributions made up of the interest paid by the borrowers within the portfolio of loans. At APG we pay distributions on a quarterly basis.
Therefore, mortgage funds provide investors with the opportunity for ongoing income in the form of regular interest payments made by the borrower. And at rates higher than a typical bank interest rate.
In addition, investors of APG’s pooled mortgage fund have the option to re-invest their profits if they want to compound their interest. This option is great for investors looking for a longer-term investment. To compare compound interest via the Distribution Reinvestment Program (DRP) with the standard pooled mortgage fund option, you may access APG’s compound interest calculator.
Are mortgage funds a good investment?
A mortgage fund is a way to gain an income stream and diversify your investments at the same time.
Mortgage funds can provide strong steady returns when managed well. But managing their risk is two-fold. Firstly by the mortgage fund manager and secondly by you, to ensure it’s a good match to your personal circ*mstances.
Mortgage funds are often just one part of an investor’s portfolio. They’re popular because they provide diversity and add value when mixed with other investment types.
Mortgage funds can provide a range of benefits to investors including:
- attractive investment returns
- passive income
- your investment being secured by mortgages over property
- the ability to decide the investment amount and term
Good quality mortgage funds have stringent risk management processes. You’ll need to take the time to compare funds, look at how risk is being managed, and assess if the fund manager has a good track record.
Diversification also plays a role to minimise the effect of borrower defaults. Look for quality properties behind the mortgages as well as diversification of lending through property category and geographic location.
Product disclosure
All the details of the funds, including risks and fees are set out clearly in a Product Disclosure Statement or Information Memorandum.
They should be read thoroughly because all the information you need is included in these important documents.
What if a borrower defaults?
This is one of the main concerns that investors have when considering investing in a mortgage fund – what happens if a loan isn’t repaid? And the reality is, that it does happen. However, the goal of the Mortgage Manager is to minimise the risk of this happening and in the event that it does, managing the recovery process.
There is a very in-depth due diligence process conducted prior to any money being lent to borrowers and the lender has to see that the borrower has a strong ‘exit strategy’ which means that they have a well-considered option for being able to pay back the loan.
One thing that private lenders do that is different from the banks is that they ask the borrower to pay the interest for the loan upfront. This means at the end of the loan term the borrower is only required to pay back the actual loan amount.
Another important factor that mortgage managers have to consider is the loan-to-value ratio (LVR) that the money is lent out at. If a property is worth $1million and the loan is for $700,000 then the loan to value ratio is 70%.
If the borrower defaults and is unable to pay back the loan then the lender is able to take possession of the security property because it has been secured with a mortgage.
The lender can then sell the property to recuperate the costs of the loan including any higher interest payments owed because the borrower didn’t pay the loan back on time as well as legal fees (if applicable).
And this is where the LVR comes in, hopefully, the property can be sold for what it was originally valued at. However, sometimes, property values can decrease which is why lending less than the total value of the property is important.
With an LVR of 70% the value of the property would have to drop by 30% for the lender to not be able to get back what is owed to them.
One of the main benefits of investing in a Pooled Mortgage Fund is that if one borrower defaults, you still have your money invested in the rest of the portfolio of performing loans.
You can read our article, ‘What happens when a borrower defaults‘ for more information on the topic.
The main way to minimise risk is to work with a trusted Mortgage Manager and Fund Manager. Active Property Group (the Fund Manager) works with Private Mortgages Australia (the Mortgage Manager) and minimises risk through:
- Extensive due diligence process conducted by experienced mortgage managers
- Conservative LVRs with funds only lent up to 75% of the value of the property.
- Investments are diversified across different property types and locations
- Operate under an independent Trustee, Primary Securities Ltd, which holds an Australian Financial Services Licence and oversees what the company does.
High returns vs. risk
Although we all get tempted by the lure of high returns, you need to also look at the associated risk. Otherwise you could be putting yourself in a situation you can’t afford. And if it seems too good to be true, it usually is.
A good mortgage fund manager will help you find a mortgage investment option to match your needs. The loan-to-value ratio (LVR) is a good way to help assess the risk. And your fund manager should happily disclose and discuss it. The lower the ratio, the more equity available for investors if problems do arise.
Regulation of the mortgage fund industry
Mortgage funds have been around a long time, but before 1998 things were a little different. In the early days lawyers or solicitors often operated as the middleman.
Borrowers contacted their solicitor for a mortgage loan who then contacted another client who might invest in the mortgage. Operating on behalf of both clients could get them into some awkward, not to mention sometimes questionable situations.
But things have changed. The Managed Investments Act was introduced in 1998 to help regulate the industry.
Can you invest in mortgages?
Investing in mortgage funds is easier and more accessible than you may think.
There’s a variety of ways you can “buy-in” that’s suitable for both small and large investment amounts. Anyone can invest with Active Property Group with the minimum investment starting at $10,000.
Remember it’s always a good idea to get advice from independent experts. People who know managed funds and can tell you if they are appropriate for your personal; circ*mstances.
Once you look at the Information Memorandum and Product Statement get in touch with the investor relations team. Take the opportunity to ask questions and learn more about the investment directly from the people who know it best.
Get in touch to find out more about opportunities to invest in mortgage funds.
