Choosing a Mortgage Fund That Fits You
Do you want to invest without having to choose individual stocks or buy an entire property?
Over the last few years mortgage funds have emerged as one of the most popular forms of REITs for retail investors looking to gain stable income from real estate.
But here’s the catch…
All mortgage funds are not created equal. Choose poorly and you tie up your money for years and earn miserly returns for the risk you take. Choose wisely and you have a great source of monthly income.
Here’s what’s coming up:
- What Is A Mortgage Fund?
- Why Mortgage Funds Are Getting Attention
- The 5x Things To Check Before You Invest
- Pooled vs Contributory
- Common Mistakes To Avoid
What Is A Mortgage Fund?
A mortgage fund is an investment vehicle that pools your money with that of other investors. This money is then loaned to borrowers who purchase real property, typically homes or businesses.
You get paid regular distributions (monthly most of the time) from the interest paid by borrowers.
Pretty simple, right?
The fund manager does all the work. They find the loans, screen the borrowers, value the collateral and manage repayments. You just get the payments.
Why Mortgage Funds Are Getting Attention
Change is happening in Australian property. Latest ABS data shows the average new owner occupier mortgage is $736,257 and demand for property finance continues to rise.
It’s that demand that presents an opportunity for investors. Here’s why mortgage funds are suddenly so popular with those searching for the best mortgage fund Australia options to match their personal finance goals…
Steady Monthly Income
Most mortgage funds distribute monthly. This matters if you’re retired, semi-retired or just desire stable cash flow. Other than a mortgage fund run by expert professionals, few investments such as shares or rental property pay guaranteed income on a set schedule.
Returns That Beat Term Deposits
Term deposit rates plunge quickly when the RBA slashes rates. Mortgage-backed funds typically fare better. Some funds are offering targeted payouts in the 6% to 7.5% range — far higher than most banks.
Property Exposure Without The Headaches
You get the benefits of property-backed investing — without:
- Tenants
- Maintenance
- Vacancy periods
- Stamp duty
The 5x Things To Check Before You Invest
Not all mortgage money is created equal. Here are five things to vet before giving your money.
1. Loan-To-Value Ratio (LVR)
LVR shows you how much money the fund has loaned against the value of the property. A lower LVR gives you more protection if property prices fall.
Fund lending at 65% LVR is inherently much less risky than a fund lending at 80%. For example, market benchmark: 16.8% of bank mortgage exposures are at LVRs of 80% or higher per APRA data.
2. First Mortgages vs Second Mortgages
First mortgages have priority if there is a default. Second mortgages are paid second (if there is anything to pay). The majority of prudent funds lend only on first mortgages for this recovery reason.
3. Liquidity And Withdrawal Terms
Here’s where many investors make a big mistake. Mortgage funds are not savings accounts. Funds may offer 3, 6, 12, or 24 month terms for investing. Ensure the term aligns with when you will need access to the funds.
4. Track Record
See how the fund has performed during difficult periods. Did they make distributions when they said they would? One of the best indicators you can have is a lengthy track record.
5. Fund Manager Reputation
The fund manager decides who to lend to, how much, when to enforce and everything in between. The manager’s discipline impacts your return. Seek managers that:
- Years in the market
- Clean compliance history
- Transparent reporting
Pooled vs Contributory
In Australia there are two categories of mortgage funds. Choosing which is best for you depends on your individual circumstances.
Pooled Mortgage Funds
Your investment is placed in a pool distributed among numerous loans. When one borrower can’t pay you, another does — keeping your payments consistent.
Pooled funds are ideal if you want:
- Diversification across many loans
- Lower minimum investments
- Predictable monthly income
- A “set and forget” approach
Contributory Mortgage Funds
You choose which loan you want to invest in. You see the borrower, the property, the LVR, the term … and you choose.
Contributory funds are better if you want:
- More control over each investment
- Potentially higher returns
- A bigger minimum is okay
The drawback? There are no other loans to absorb the shock if yours performs poorly.
Common Mistakes To Avoid
Even smart investors mess this up. Watch for these traps.
Chasing The Highest Return
A fund offering 12% is not inherently superior to one offering 7%. Higher returns = higher risk. Remember to ask yourself: why is X% so high?
Ignoring The PDS
The Product Disclosure Statement is the fund’s way of telling you what can go wrong. It’s dry and wordy, but read it anyway.
Forgetting About Liquidity
Don’t invest funds that you will need for next month into a 12-month investment fund. Sounds simple but people do it anyway.
Not Diversifying
Diversify within mortgage funds too. Don’t put all your money into just one fund, term or manager.
Final Thoughts
Selecting a mortgage fund is really a matter of selecting the fund that’s right for you. There is no one “best” choice for everyone — only the best choice for you.
Quick recap:
- Check the LVR and security position
- Confirm the fund holds first mortgages
- Match the investment term to your needs
- Look at the manager’s track record
- Read the PDS before you commit
Find an appropriate fund, kick back and watch the monthly income come rolling in.
Frequently Asked Questions
Are mortgage funds safe?
Mortgage funds are secured by real estate which adds a degree of safety to your investment that other types of investments can’t always offer. However, there is still risk involved. Returns are not guaranteed and your capital is at risk should borrowers fail to pay.
How much do I need to start investing?
Minimum investments range. Pool investments are lower (some as low as $5,000) and contribution funds require more.
How often do mortgage funds pay distributions?
Most pooled mortgage funds pay distributions monthly.
Can I withdraw my money any time?
Typically not. Mortgage funds have defined investment periods. You must either wait until the period ends or provide notice during a withdrawal period.
What’s the difference between a mortgage fund and a term deposit?
Term deposits are covered by the government guarantee. Mortgage funds are not guaranteed but generally offer a higher interest rate to reflect the additional risk.