The 10 rules for choosing the best mortgage fund to boost your income

The cause of renewed investor interest is the search for an alternative to low savings and fixed bank rates, especially among retirees looking for regular, reliable payments that offer a return above inflation.

The annual return of an average $100,000 term deposit account is $520 (or 0.5%). The return on the same amount in an average savings account offering 0.3%, excluding bonuses and no additional payments, is around $300, according to analysis by Canstar, which monitors rates.

“Investors considering mortgage funds need to look under the hood and understand what is driving returns,” Daley says.

The attached table shows a range of mortgage funds from established providers offering yields of around 5-7.5% with investment terms ranging from one month to five years.

Investors considering real estate mortgages can choose between contributory mortgages and pooled mortgage funds offering everything from conservative residential projects to highly speculative commercial and industrial developments.

Contributing funds allow investors to buy an equity stake in a real estate developer’s mortgages, ranging from townhouses and apartments to small commercial buildings. These are managed by fund managers who allocate funding to projects that traditional lenders may find too risky. As such, they are paid higher rates by developers.

Some fund managers provide lists of projects that an investor can match their appetite for return and risk.

Alternatively, investors can choose a pooled mortgage fund where the underlying properties, which may include a mix of residences, businesses and industries, are managed by a fund manager.

According to the Australian Securities and Investments Commission, investors should speak to their financial adviser, read the product disclosure statement and seek clarification from the system managers on any outstanding issues.

Major benchmarks that should be considered by an investor include:

  1. The track record of the team offering the product. Roy Prasad, managing director of mortgages at Australian Unity, says experience in managing projects, especially at a time when there are serious supply issues, requires experience and an understanding of the Marlet. “There are a lot of new managers who promise a lot,” says Prasad. “But many don’t have the experience of successfully managing a fund through the ups and downs of an economic cycle.”
  2. Scheme borrowings. Investors should be sure that the program is not too biased. Ask for an explanation if a loan-to-value ratio is higher than 75%. How much money does the scheme owe and when do the debts need to be repaid? How much can the plan borrow compared to what it has already borrowed?
  3. Liquidity. “It’s an extremely important consideration,” says Daley of Hardline. “Investors need to know how long their money is being invested for and the costs of early withdrawal,” he says. Does the fund have the cash to return money in the short term?
  4. Evaluation. Is there an independent evaluation panel? Are the lawyers and quantity surveyors independent? “Investors need to ensure that there is an independent assessment of projects,” says Prasad. “They need to make sure those offering advice are independent.” Check if there are procedures to manage potential conflicts of interest.
  5. Related Party Transactions. Make sure that advisers who claim to recommend funds independently do not receive kickbacks or commissions from project managers.
  6. Return level. Australian Unity’s Prasad warns that many investors are drawn to funds offering double-digit returns without asking how the rates are achieved. “If it sounds too good to be true, it probably is,” he says. “The market will offer certain levels of return. Excessively high returns could be a warning about higher risks.
  7. Rise in interest rates. Yield spikes can be attractive to short-term investors, but can put borrowers under pressure.
  8. Withdrawals and repayment of capital. Most contributory mortgage schemes only allow withdrawals when the invested mortgage matures. Group mortgage plans allow for short-term withdrawals. But in most cases, it can take up to 12 months to get your money back, according to ASIC.
  9. Diversification. A portfolio heavily concentrated in a few loans, or loans to a handful of borrowers, increases risk. Are the projects of different sizes with different borrowers and based in different geographic regions? ASIC recommends that no asset represents more than 5% of the total fund and that no borrower be loaned more than 5% of the mortgages in the fund. Daley recommends investors review average loan sizes, loan-to-value ratios, loan terms and portfolio diversification to ensure risk is diversified.
  10. Advisors recommend that mortgage funds not represent more than 10% of an investor’s portfolio.