Non-Bank Lenders Explained: What Are They and Their Benefits?
Non-bank lenders have successfully made their way into the lending industry.
But What Exactly is a Non-bank Lender?
It is a financial institution, just like traditional banks where they offer home loans, among many other types of loans. However, the main difference is that these non-bank lenders do not possess a banking licence.
Non-bank lenders are not just dissimilar from banks, but they also operate differently from financial institutions, such as credit unions.
For one, these entities are not considered authorised deposit-taking institutions or ADIs, which means that they cannot take deposits from their clients. So, how do they get their funds? There are two main ways:
Non-bank lenders have to look for their own sources from other places, such as through investors, overseas firms, and Australian Banks’ wholesale funds. Generating profits is easy once they have the funds. They will sell the money to their clients with an interest rate, which is where they get their revenue.
The second method is through securitisation, which is a type of mortgage that is backed by security. The Reserve Bank of Australia (RBA) defines securitisation as a way to exchange illiquid assets (such as mortgages) into tradeable securities. It has many benefits for these lenders, including the fact that it is cost-efficient and gives the ability to convert asset-related risks.
The mortgage industry struggled for several years. It has now come a long way since the Global Financial Crisis (GFC), which generated fear about what could happen in Australia and internationally. It appears as though we are facing the same situation again.
During that time, the GFC led to a shift from small and independent lenders. Customers sought the assistance of big banks because they were thought to be a safer and better option.
Despite the small similarity with the GFC, this pandemic is causing consumers to go for non-banks instead. Why is it so? One huge reason is that non-bank lenders have demonstrated their value over the years. They have stood firm against their proven rivals, the major banks. It is why the Australian home loan market remains bolstered with the competition.
More Differences between Non-Banks and Traditional Banks
Another main dissimilarity that separates mainstream lenders from non-bank institutions is the authority behind them. The Australian Prudential Regulatory Authority (APRA) is the agency designated to regulate most ADIs.
For decades, banks are perceived to be the safest option when taking out a loan. Part of this observation is due to the intense government regulation and scrutiny that banks are subjected to. However, the same is also true with non-bank lenders.
The Australian Securities and Investments Commission (ASIC) handles non-bank lenders. ASIC has rules that compel non-bank lenders to comply with legal and industry policies. From the ASIC laws to the National Consumer Credit Protection laws to the Australian Consumer Law, these are just some of the regulations that non-banks have to follow.
The APRA does traditional subject banks to an additional layer of codes. Over recent years, though, the APRA has some involvement in regulating non-bank lenders. Nevertheless, the institution’s role is generally concentrated on advising the lenders rather than imposing rules and regulations.
Perhaps one of the biggest debates about whether to go with a bank or a non-bank lending institution is about the interest rate. A frequent question that borrowers ask is if they can get a better interest rate with a non-bank lender. On the surface, banks show that they have the best rates offered. Their products are appealing, and they have the upper hand in the trust department as well.
However, non-banks have evolved over the last few years. In essence, they are competing with major and smaller banks, as well as other popular lending organisations.
One of the ways for them to gain customers is to offer better interest rates than big-name banks. They found a path that would help them undercut the costs of their products while lowering their interest rates. This way, they have a growing number of borrowers that can help them stay alive while contending with traditional banks. We discuss interest rates more below.
Should You Consider a Non-Bank Lender?
It seems like a financial collapse is currently underway, with the COVID-19 pandemic hurting the world economy. Businesses and individuals will soon find it difficult to get loans. The period after this ongoing trial is crucial. While the interest rates recently reached a record low of 0.5%, it does not mean it will stay low for a long time.
Soon enough, this interest rate will increase, and it will be difficult for people to get the loan they need. It is why an increase in the number of borrowers trusting non-banks over traditional banks is evident, especially with the pandemic going on. For customers, they see the massive difference between the two. At the same time, they experience the benefits of dealing with non-bank lenders, which include:
1. Fast Cash Access
If you have tried to get a loan from the bank before, you know how the process works. It is lengthy and demanding. Worse, there is no way for you to get a glimpse of your chances for approval. This issue is non-existent with non-banks.
After lockdowns and restrictions are lifted, companies will operate and try to get things back to normal. However, cash is mostly a problem. Many companies will face difficulty in providing the funds they require for daily functions, accounts payables, and payroll, among others. At the same time, these organisations cannot waste their time filling out forms and meeting requirements of traditional banks. They demand fast access to ready cash, and non-banks can supply them just what they need.
2. Easy Application Process
Dealing with banks does offer forms of security to investors. Plus, their rates are often attraction, particularly at first glance. However, a huge dilemma that investors & businesses face as they try to borrow money is the long wait.
When you have a business to run, you cannot afford to lose a lot of time. After all, time is money, no matter what industry you are in. When you apply with a bank, you will have to wait for weeks or even months to get the approval. Also, you will need to wait more just to receive funds.
With non-bank lenders, you can start handling the financial stress caused by COVID-19 right away. It is because they offer quick application processes. When approved, you can get the funds in just a few days compared to weeks or months.
3. Flexibility for Borrowers
Specialist non-banks have made a name for themselves in the banking industry. While banks steer clear of troublesome borrowers, non-bank lenders are (a little) more forgiving. For instance, they may provide loans to those who have a negative credit history. Most banks have remained stubborn throughout the years when dealing with high-risk customers. It is their way of protecting themselves against the customer’s chance of default.
Non-banks have created products that are designed for credit-impaired borrowers. Those who need immediate funds and do not mind additional application fees, interest rates, or price valuation costs, these lenders are the answer.
4. Unique Repayment Assessment
Non-banks are not covered by the traditional regulations that concern mainstream banks. Instead, they use various methods to evaluate customers existing and new debts.
Here is a breakdown of the repayment assessment:
- A certain percentage of actual repayments will be considered. For this example, let us say the rate is 1.05%. Based on the percentage, the non-bank lender will use it on the existing loan of the customer. In this scenario, the customer currently has $2,500. The lender will assess this loan amount as $2,625.
- For new loans, there is a buffer on the actual rate, which will depend on the lender, but it is usually at two per cent. In this same example, this lender assesses the new loan at 6.69%, where the actual rate is 4.69%.
Taking all the numbers above, a particular customer takes out a $500,000 loan with the non-bank lender. The actual repayment should be $2,590. However, because of the additional rates, the total repayment will be $3,223 – if it is a 30-year loan with principal and interest repayments.
On the other hand, here is the breakdown of the repayments with a traditional bank:
While banks differ in interest rates, which will typically depend on the borrower’s credit history, new loans will be assessed at a higher rate. For instance, if a customer takes out a loan with the Commonwealth Bank of Australia (CBA), the loan rate for the new loan will be assessed at 7.25%. In other instances, it will be the original loan rate in addition to the 2.25% appraised value.
As with the same example above where the interest is 4.69% on a $500,000 loan, the customer should repay $2.590. However, the assessment of the CBA will increase the repayment to $3,410 because of the 7.25% assessment.
As evident from the numbers, traditional and non-bank lenders are different in their assessment. While the way new loans are evaluated may not be that dissimilar, the distinction lies in the appraisal of existing debts.
5. Better Borrowing Capacity
Another big advantage is with the maximum capacity of borrowers to get funds from the non-bank lenders. Let us say that the borrowers are a couple with two dependents. They have a principal place of residence valued at $500,000. The property has a $200,000 loan with a four per cent interest rate. This couple also has an investment property valued at $300,000 and a $240,000 mortgage with 4.50% interest. They want to buy another investment property, which will be at an 80% loan-to-value ratio.
Both the bank and non-bank lenders will assess these borrowers, taking their annual gross, credit card details, including limits, and household living expenses.
After calculating, the non-bank lender offered the borrowers $925,000, while the Commonwealth Bank of Australia only provided $550,000. The maximum borrowing capacity between these two institutions clearly shows that non-banks are the better option. If you want to get the highest possible amount that you would like to borrow, you have a greater chance of attaining it if you deal with non-banks.
This difference mostly lies in how a customer’s existing debt is evaluated. With the non-bank giving $375,000 more than the traditional bank, borrowers know where they will benefit more. With the pandemic affecting finances, consumers want to secure their future. The promise of higher maximum borrowing capacity makes non-bank lenders a more attractive option than banks.
How to Get the Most Out of a Non-Bank Lender’s Offer
As you can see from above, non-banks offer great benefits for their customers. However, it is still important to stay smart. Non-banks are not created equal. Some are better than others, especially with their offered deals. Before you sign an agreement with a non-bank lending organisation, it is your job to practise the following:
1. Build a Risk Mitigation Plan
It is proven than non-bank lenders are more generous than conventional banks. They are more willing to provide a loan to their customers. Even those with poor credit history have a higher chance for approval compared to bank loan applications.
However, it does not mean you should fully trust the non-bank lender. You should still be a wise customer and create an exit strategy for your own good. Some exit strategies when borrowing money from non-banks include putting the loan portfolio up for sale and refinancing the loan.
Often, customers choose to refinance their loans elsewhere. It is much easier and less of a hassle. Still, the borrower should only go for this route if there is an expected increase in income, or at least the total debt will soon be reduced. If you do not have an exit strategy, you could end up paying more interest rates and fees.
2. Understand That Non-bank Borrowing is Best for Short-term Loans
If you see that you have a chance at a thriving real estate market, for instance, and you need extra funds, you can turn to non-banks. These lenders are also your best options for taking advantage of quick capital gain opportunities.
In short, you need to act now. If you do not, you lose the opening. In such cases, non-bank lenders are more suitable than traditional banks. You get to benefit from the short-term gain, which you usually cannot enjoy when you go for banks.
3. Make the Most Out of the Specialist Products
While many banks are not willing to accept applications from high-risk individuals, non-bank lenders do not have this same issue. In fact, they even provide specialist products to their borrowers.
Non-banks may offer reverse mortgages, for instance. They are a type of loan specially designed for retirees and pensioners who have a lot of assets but may not have enough cash. This product is also called a senior’s loan or finance. The borrower can get a loan based on the equity in their home. It will be converted into payments which the lender pays.
Many banks are not keen on providing specialist products, such as a reverse mortgage. Only alternative lenders allow seniors to access their funds through this option.
4. There Are Limitations in the Product Features Non-banks Offer
While there are specialist products from non-banks, they also lack certain functions. It is why you should first research on the availability of the product you need before you agree with the lender. An example is that some lenders do not offer an offset account.
It may still be unlikely, but a GFC mark 2, or if the economy is under extreme conditions, funding sources may be cut off in the future. It can affect a portion of non-banks. As a result, interest rates could go high, and your loan might even get sold to another lender. Such a scenario could happen if your current lender goes out of business.
In reality, though, it is a case that could happen with almost any lender, whether big or small. However, it is highly improbable if you choose to work with a major bank. With the ongoing pandemic, it becomes more important than ever to have an exit strategy, as mentioned above.
5. Steer Clear of Lvr That is Higher Than 80%
To keep your repayments affordable, avoid reaching more than 80% LVR. Before this percentage, non-banks are almost less expensive than traditional banks. Fees, however, start to creep up when the LVR is over 80%. Keeping the LVR to this percentage will lock the valuations and other fees, such as establishment and applicant costs, to an ideal rate.
6. Non-banks Can Stop Operating
These lenders work just like any other business. They can have bad days as well. With the coronavirus affecting many transactions, it may cause some lenders to close. Before you start panicking, you can take comfort in the fact that regulations govern non-banks. They protect you as a customer, similar to how traditional banks provide coverage.
Also, non-bank lenders are not ADIs. Therefore, you will not deposit funds with them. If your current lender goes bust, you should still remember that you have a duty to make repayments.
Is a Non-Bank Lender for You?
Having considered the benefits of working with a non-bank, you may be wondering if such a lender is suitable for your situation.
Although there are regulations that govern them, non-banks do not have as many restrictions as traditional banks. It is why they can offer the flexibility to give the borrowers the funding they need.
You may have submitted your loan application with a major or even a smaller bank. However, your request was denied. You should not lose hope because non-banks are here to help you out. Most big banks have a significant reason why they turned down your request for a loan. It may be due to a low credit score, bad credit, and having a high debt-to-income ratio.
If at least one bank turned your application down, you likely get declined again. Self-employed professionals often have a hard time with their loans. It may also be the reason why you did not get approved.
If you think you can no longer borrow money, non-banks are the solution. Fast processing is one of the advantages, which means that they can quickly close the transaction in a few days.
Aside from having bad credit or getting rejected by major banks, you can also consider the type of loan you require. Non-bank lenders offer various products, but they may not be as comprehensive as traditional banks. Nevertheless, if you need a basic home loan, you can turn to a non-bank. Here are some of the common types of loans that these lenders provide:
- A basic home loan is the most common type that non-banks offer. It comes with either a variable or fixed rate. Features are not as broad as with conventional banks, but they can have some useful offers as well, such as a split rate.
- A full-featured standard loan is another home loan offered. It has more benefits than a basic home loan. For example, it can come with the benefits of an offset account, as well as the ability to provide extra repayments and use its redraw facilities.
- Bad credit home loans are exclusively for those who have a bad credit history. Because of the borrowers’ high risk, lenders will apply a much higher interest rate than usual.
- Investment loans are for those who need to purchase an investment property. If you cannot buy a property without taking out a loan, you can use this type of home loan. Note that it only applies to an investment property, which means it should generate income for you.
Low doc loans come with minimum requirements. Often, this type of loan also involves fast approvals.
As the mortgage industry continues to evolve, so do non-bank lenders. Many people assume that major Australian banks are the most secure. Therefore, they are the best option when taking out home loans. However, non-banks have become competitive with rates that rival big banks.
If you are an investor and the APRA’s tightening regulation has impacted you negatively, non-bank loans may be the solution moving forward.