What Is Second-Tier Lending and How Can Investors Take Advantage?
If you are an investor wanting to grow your property portfolio, then second-tier lending as a finance strategy needs to be on your radar.
Over the last 12 to 24 months the New Zealand property market has seen a range of unique conditions. Everything from exuberant growth right across the country, to stricter lending laws taking place and now the rise of interest rates.
The combination of these, and other market factors has left many property investors scratching their heads and wondering how exactly they’ll take the next step in building out their portfolios in 2022.
WHY SECOND-TIER LENDING IS BECOMING POPULAR
Those who have bought or held property over the last couple of years now have a healthy parcel of equity sitting in their portfolios. But the challenge isn’t having equity, instead – it’s actually being able to use it.
See, it’s all very well and good owning a property that has seen high levels of capital growth, but if you don’t actually then use that equity to purchase again, then the value of that property is nothing more than a vanity metric.
You can learn more about equity and how it works here.
The number one issue we’re seeing property investors run into right now, is not that they don’t have the capital to reinvest – it’s strict lending laws and rising interest rates that are limiting people’s ability to tap into their equity.
Accessing money from a traditional bank is becoming harder, and it’s becoming more expensive too. But there’s one major opportunity available to property investors at the moment that could change the game completely – it’s called second-tier lending.
WHY YOU NEED TO BORROW MONEY
First, let’s briefly explore why we need to lend money in the first place.
Lending money to invest in real estate binds property investment together. Without taking on debt or risk, the average person will seldom advance financially in life.
Put simply – without borrowing money, we as investors would be limited and completely stuck.
The idea is to use someone else’s money – eg; the lender’s money – to build a property portfolio that will grow in value and create a passive income for later on in life.
WHAT EXACTLY IS SECOND-TIER LENDING?
So, what’s second-tier lending anyway? First, we need to understand what first-tier lending is.
Under the Reserve Bank all of the main banks are governed by specific regulations and have rules that they must adhere to. Also, because they are influenced by the Reserve Bank, they all follow the leader when it comes to the rise and fall of interest rates.
However, second-tier lenders are different. They are not controlled by these same regulations and therefore have a lot more flexibility in who they can lend to. Building societies and credit unions are classified as second-tier lenders – they are basically non-bank lenders.
These loan providers do however still have to follow responsible lending laws.
THE DIFFERENCE BETWEEN FIRST & SECOND TIER LENDERS?
When it comes to using the big banks or non-bank lenders, there are pros and cons to both. The most obvious is that while second-tier lenders are generally a lot more flexible when it comes to getting an approval for a loan, typically they’ve always been a little more expensive.
For example, if you were going to pay 5 percent with a main bank, you’re normally going to pay 1.5 to 2 percent more with the second-tier lender.
Traditionally people would only use second-tier lenders if they couldn’t get a loan from a bigger bank as a short-term option because it’s a lot easier to obtain finance and get a foot in the door.
WHY WOULD I USE A SECOND TIER LENDER?
Compared to the screens of information the main banks are looking at, a non-bank lender requires very little personal information. Generally speaking, they won’t comb through three months’ worth of bank statements and check every single transaction record.
On top of this, many are now bringing out some competitive products that could change the game for investors!
For example, one of the second-tier lenders is now doing a 20-year interest-only offer which is pretty much unheard of.
What would the advantage of this be for an investor you might be thinking?
Well look at it like this – let’s just say you had a $600,000 mortgage with one of the main banks. They may have granted you a small interest-only payment period but now you have to pay principal and interest on your loan. In some cases it could be cheaper to go to the second-tier lender at a higher interest rate and go interest-only.
WHEN INTEREST-ONLY LOANS ARE BETTER
As an investor, there’s a time and a place for interest-only and for principal and interest loan repayments.
During the acquisition phase of your property investor journey, your primary aim is to purchase the right properties, not to pay down your debt. Embracing debt can take a while to get used to, but you need to think about the long game and what you’re trying to achieve, i.e. many properties, all creating wealth.
If you can get an interest-only loan in your acquisition phase, this is 100 percent what you should do.
Because interest-only loans give you flexibility with cash and that flexibility allows you to move on to the next property faster. Having access to spare cash is vital in your acquisition phase, which can last for years. If you’re paying every last cent you have to get down your principal, where is the next deposit amount going to come from when you want to buy a second, third or fourth investment property?
Picking the right home loan is important and you can read more about your options here.
SUMMARY – THE BENEFITS OF SECOND-TIER LENDING FOR INVESTORS
There was a lot of good that came out of 2020 and 2021 for property investors. The most obvious was major capital growth. In fact, almost every man and his dog in New Zealand who owns property now, has gained a lot of wealth on paper through equity because of how quickly values have risen.
But being rich on paper doesn’t count for much if you can’t use that equity because no bank wants to touch you.
However, the emergence of non-bank lenders means a ‘no’ from the bank last week, could be a ‘yes’ from a second-tier lender this week, meaning investors can grab their equity and run with it in order to continue to build out their portfolios.
Oftentimes when market conditions are less than ideal, people sit on their hands and ultimately get left behind. In real estate, action equals money so looking for alternative ways to keep moving forward is a smart decision.
EITHER WAY, SPREAD YOUR RISK!
Regardless of whether you go with a main bank or a second-tier lender, you want to make sure that you spread your risk and don’t put all of your eggs in one basket.
Most banks or financial institutions have clauses in their loan documents that entitle them to review any one of the property loans you hold with them at any time.
Some property owners can be caught napping, as the banks can ask for additional funds if they believe the property value has decreased.
This clause means the bank is entitled to use equity in any of your other properties, held with the same bank, to ensure they are protected from changes in property values, even if it is not specifically related or attached to the original loan.
In other words, all properties are security for all loans with the same lender, which can severely limit your investing future. The clause is known as the “all monies clause.”
The alternative is to use securitised lenders (again, non-bank lenders) or to be diverse by using more than one bank.
Therefore, the result is that any funder you have borrowed money from to invest can only use an individual property as security within your property portfolio.
Understand that the best way to control the bank loan terms and conditions is to use a new funder every time you invest. It is very important to be in control of your financial future.
Sophisticated borrowers, who want to grow their portfolio without the risk of the lender reviewing their complete financial position every time they apply for funds to buy another property, do not cross securitise their properties unless it is necessary. This is the best way to move forward easily.
SECOND-TIER LENDING IS A MAJOR OPPORTUNITY!
For property investors who thought they’d have to watch their equity slowly go to waste, there’s now another option with second-tier lending.
With the right product and terms and conditions, second-tier lending could give you a massive advantage when it comes to creating wealth over the long-term.
However, when it comes to smart investing, lending in itself requires a solid strategy.
The basics listed in this article are a great start but there are many more ways you can improve your finance structure for better returns and a stronger portfolio. To learn more, join our free property investing seminar.
Our expert property coaches are exceptional at helping investors build a wealth creation plan that optimises every available opportunity for new and existing investors.
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By Sue Irons
CEO – Positive Real Estate New Zealand
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