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Mortgage-backed securities (MBS) and collateralised debt obligations (CDO) have a bad reputation among some investors in the financial world.
This can be traced back to the 2007-08 Global Financial Crisis, when the excessive creation of MBS and CDO led to property prices being driven up, only for U.S. housing prices to crash, leading to major defaults on homes and subsequently, huge financial losses for many banks and retail investors who have invested in these MBS and CDO that were backed by the cash flow from these mortgage investments.
Regrettably, this has caused some investors to avoid collateralised debt investments even though they are technically safer than unsecured loans. The idea behind collateralised debt investments is that it is safer to lend someone money when you have claim over their assets in the event of a default.
Given the uncertainty over the economy today, Funding Societies, Southeast Asia’s largest P2P lending platform, has introduced a product called Property-backed Secured Investment. According to Funding Societies, there has been no defaults in this product since it was launched 2 years when.
How Property-Backed Secured Investment Works?
To understand how Property-backed Secured Investment works, we first need to know how Funding Societies operates.
As a P2P lending platform, Funding Societies helps match borrowers (i.e. SMEs who need to borrow money) to lenders (investors who are willing to lend in exchange for high interest rates).
An interest rate is set by Funding Societies on behalf of investors. This interest rate is dependent on the credit quality of the SME borrowers who are assessed internally by a team of credit officers accompanied with their proprietary credit scoring algorithm. Naturally, SMEs that are deemed as more creditworthy will be charged a lower interest. Investors can expect a return of between 3% to 18% p.a. across a variety of guaranteed returns, secured and unsecured investments. Funding Societies charges a fee of 18% of the interest earned by investors.
To lower the interest cost to borrowers, and also reduce the risk for investors at the same time, Funding Societies introduced the Property-backed secured Investment, where SMEs can pledge their properties to secure the loans and thus enjoy lower interest rates.
Here are 4 things to know about how its Property-backed Secured Investment works before investing in it.
#1 Your Loan Is Secured By A Property Owned By The SMEs Or Its Directors
Funding Societies only provide short-term loans of no more than 12 months. Also, all of its SME clients are required to pledge a personal guarantee when applying for a loan with Funding Societies. In other words, if the company fails to make the promised repayments, the directors who guarantee the loan are personally liable for the repayments.
Of course, this doesn’t mean the loan is 100% secured. If a company goes bust, going after the directors may also be a futile effort if he/she declares for bankruptcy.
To mitigate this risk, the Property-backed Secured Investment takes collateral in the form of properties. In the event of a default, Funding Societies has the legal right to auction off the properties, thus providing an additional recourse for investors.
#2 Residential, Industrial Or Commercial Properties Can Be Pledged
Investors who provide the loans are not purchasing or investing in the property that is being pledged. Instead, the property is already owned by the company or the director, who is pledging it as collateral as part of the loan arrangement. This would usually be a residential or commercial unit. While the borrower still owns the property, Funding Societies has the legal right to sell the property if there is a loan default to recoup its loan.
#3 Maximum Loan To Property Value (LTV) Is 80%
If the valuation of a property (e.g. a condominium) is $1 million, Funding Societies will only approve a loan of up to $800,000. This is a Loan To Property Value (LTV) of 80%. According to Funding Societies, the majority of business loans are approved at 70% of the LTV or below. This provides a buffer of at least 20% for price adjustments based on market conditions in property value. Most of the properties accepted as collateral are unencumbered, or free of charge or mortgage. The forced sale value of the property is always greater than the amount loaned; this provides assurance for the lenders.
#4 Expected Returns Of Between 4% To 8% P.A.
As compared to its unsecured business loans, expected returns for the Property-backed Secured Investment is significantly lower at about 4% to 8% p.a. This comes as no surprise, given that these property-backed loans are extremely safe because of the collateral that is being held in the event of a default.
The returns are lower, but this is also because the risks are much lower – in line with the risk-return trade-off concept.
Fees charged by Funding Societies is the same as other products it offers, at 18% of interest. If the interests earned by investors is $1,000, $180 is payable to Funding Societies.
If you are interested to know how a Property-backed Secured financing fact sheet looks like, check out a sample below from Funding Societies.
Source: Funding Societies
You can also check out the Funding Societies FAQ page on this product.
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