Caveat Loans – Is the risk worth the reward?

In recent times, tighter restrictions, limits and controls placed on public banks has seen the rise of developers and business owners looking to private funding and mezzanine arrangements to bridge the gap in funding between their financial requirements and what funding they can obtain from traditional financiers. Along with this rise has seen the increase of what are commonly referred to as “caveat loans”.

What’s a caveat loan?

A caveat loan is a type of loan arrangement where the repayment of the loan is “secured” by the borrower or its guarantor granting an interest to the lender in their real estate property (usually in the form of a charge or mortgage) sufficient to entitle the lender to register a caveat over that property.

What is a caveat?

A caveat is an instrument that is a form of notification lodged on the title of the property which gives the caveat notice of any dealings relating to the land, and is intended to prevent the owner from dealing with the land without prior consent from the person who lodged the caveat.

This is contrasted with a mortgage of land which specifically grants a security interest in the land such that the holder of a mortgage can exercise a power of sale to sell the land if the borrower defaults in its obligations.

Typical caveat loans require a borrower to sign a mortgage document to grant the lender rights as a mortgagee who then can lodge a caveat to register their interest.

Why are caveat loans used?

Private lenders often prefer providing caveat loans, because they provide a practical and rapid mechanism intended to protect their interest as lender/mortgagee on title without having to consult with any third party. This is contrasted with seeking to register the mortgage itself on title which has more onerous requirements including having to obtain consent from any previously registered mortgagee’s or caveators or other interest holders who may offer resistance to another party lodging an interest.

Speed is an obvious advantage for mezzanine or bridging loans where there is often an urgency to the advancing of funds. Borrowers seeking caveat loans are often in precarious situations where they may need urgent funds in order to complete a settlement or progress a development. They may not have the time to go through a traditional lending process with the bank or may have already been denied traditional funding for some reason or another.

Moreover, caveat lenders in this sphere are prepared to lend based on much higher risk and on less detailed information and higher LVR (loan to value ratios) in exchange for charging higher interest rates and fees. The rule of thumb generally being if the lower the security then the higher the interest that can be charged – risk vs reward.

What’s the risk?

There is a common misconception that somehow a caveat gives caveators (the people who register caveats) them rights over the property or that somehow a caveat is synonymous with a mortgage. This is a misunderstanding. A caveat does not equate to security. A caveat does nothing but notify the Registrar of titles that the caveator has an interest in the land such that the Registrar will not register any change to the register without the caveators consent. The caveat it does not itself provide any rights over the land.

There are several practical disadvantages of this. One is that if you have only registered a caveat then any rights the lender has as mortgagee are only rights in equity. Therefore, to do anything to the property in enforcement of your rights (E.g. to sell it) you would need to either seek to register any mortgage which would require the consent and cooperation of any registered mortgagees or pre-existing caveators or you would need to obtain a court order.

However, a further significant risk for a lender in only lodging a caveat on a security property rather than registering a mortgage is that a caveat does not create any priority for a mortgagee. As mentioned above it only serves as a warning to others that the caveator has an interest in the property. The strength of the caveators rights will depend on the underlying document which creates the interest in the land and the priority of the caveators rights will depend the date of that document when compared to the date of the creation of any competing interest holders’ rights.

This will have implications on who will get paid out first in the interest that the property owner/borrower cannot pay all of the creditors who have security over the property.

For example, if a lender has only registered a caveat in respect to a debt owed (to which it would have an unregistered mortgage) they may still lose out in priority to a party who may have registered a caveat after their caveat but whose underlying mortgage predates theirs.

This would not be the case if instead of registering a caveat the lender actually registered its mortgage. If the lender has registered its mortgage it would have a legal interest in the property as mortgagee and would have priority over all unregistered interests (even ones which predate yours) or subsequently registered mortgages. This is not to say that a registered mortgage is “bullet proof”. Mortgages have their own risk, however, suffice to say that a registered mortgage is generally a superior form of security than an unregistered mortgage supported by a caveat .

Conclusion

Whilst Caveat loans have become useful arrangements for lenders and borrowers to facilitate speedy “secured” loans, lenders should consider the significant risks carefully and carry out appropriately thorough due diligence on the borrowers financial position, and the security property. Loan documents and the underlying security documents should be prepared with care to ensure they are enforceable and the lender is aware of where they sit in terms of priority in the event that the borrower defaults.

At Tisher Liner FC Law we regular assist lenders and borrowers with preparing the relevant documents to create effective caveat loans and if you have any queries regarding the same, please contact of Jeremy Quah or a member of our commercial law or property law teams.