Whether you are lending your child money to help them enter the property market, a friend to help grow their business or to someone for their everyday expenses, you need to ensure that your interests are best protected by securing your Loan Agreement.
Lending money to someone, even close family members, has its risks. It is important that you, as a lender, have your money properly secured in case anything goes wrong.
It is our advice that all loans should include a Loan Agreement. A Loan Agreement is a document signed by both the lender and borrower which includes terms and conditions that both parties are bound by. For example, the loan amount, length of loan, repayment amounts and interest (if applicable). It also outlines what happens if the borrower was to default on any terms of the loan. Whilst a Loan Agreement alone can provide a lender with some safety, it provides the lender with no security.
So, what are the most common types of security you can request when lending someone money? The below are the different types of security available for a lender to request, in order from the highest level of protection to the lowest.
Registered Mortgage
The most common form of security and what we would call ‘gold standard’ is to register a mortgage over the borrower’s home or investment property. This occurs when the borrower provides the lender with a security interest over their property. For example, when you borrow money from a bank to purchase a property and they register a mortgage over your title.
When a mortgage is registered on title, lender’s lawyer will have control of the title and any title searches will show that the lender has first priority meaning the property can’t be sold or used as further security without the lender’s knowledge.
A mortgage allows the lender to exercise rights over the property if the borrower defaults on the loan in any way. These rights can include taking possession or forcing a sale of the property.
A registered mortgage also ensures that if the borrower was to enter financial hardship or be declared bankrupt you will be the first to be repaid from the funds that are still available.
Registered Second Mortgage
A second mortgage is a mortgage over a property that already has a registered mortgage on title. It operates in the same way as a first mortgage, except that it places you second-in-line for repayment of debt following default by the borrower.
A second mortgagee is still able to foreclose on the property in order to secure repayment, however any subsequent property sale will result in the first mortgagee receiving funds prior to the second mortgagee collecting payment. In the event that the property does not sell for a price that is enough to repay both loans, the second mortgagee may find they are unable to be repaid in full.
Prior to lodging a second mortgage, it is essential to understand the scope of the first mortgage, and confirm the borrower is able to make both repayments.
Unregistered Mortgage
An unregistered mortgage gives a lender priority over any of the borrower’s unsecured creditors however, it does not give you the same entitlements or benefits as a registered mortgage.
For example, the borrower can sell the property and flee with all the sale proceeds. Further, the borrower could obtain another bank loan and have a mortgage registered over the title without your permission. Therefore, if there is not enough equity in the property after the first mortgage is repaid you are at risk of recovering no money.
Although the mortgage creates an interest over the property and a legal promise that the borrower will repay the debt, it does not give the lender the power to sell the property in the event of a default by the borrower.
PPSR
The Personal Property Security Register (PPSR) is a government register of a security interests in personal property which is any asset that is not land.
A PPSR registration is often used when lending money for the purpose of smaller loans (such as for a car purchase). It is also useful when lending money for business purposes, as you can register your interest over the assets of a business.
We recommend that you enter into a General Security Agreement that allows you to register your interest on the PPSR when you lend money that is not for the purpose of purchasing real estate, or where a registered mortgage is not possible.
For example, if you decide to lend money for the purchase of a business, and the borrower does not own real property, you can register your interests over the borrower’s personal property. If the borrower was then to sell the business, a prospective purchaser would search the PPSR and see that you had an interest that needed to be repaid in order for the sale to take place.
Under Personal Property Security law, you can enforce your security interest if the borrower defaults on the loan agreement. The manner in which enforcement takes place (repossession of goods, seizure of bank accounts) can be dependent upon the size of the loan and the type of goods secured.
You can read more about the PPSR on our Blog Post here.
Caveat
A Caveat does not provide security for your loan and is generally not recommended for lenders. A person who lodges a caveat has no rights over the property it is attached to, beyond the right to receive notice of any proposed dealings on the title. A dealing can include a transfer of the property, or a registration of a mortgage.
That being said, a Caveat can be a useful tool in situations where you would like to register your interest in a borrower’s assets without going to the expense of registering a mortgage, perhaps for a smaller, short-term loan.
It does not give the lender a right to foreclose on the property, but it can help to ensure that the borrower repays the debt to you upon the sale of the property.
Loan Agreement Only
An unsecured Loan Agreement does not require the borrower to provide any collateral as security for the loan. Instead, it relies on the lender satisfying themselves that the borrower is able to service the loan.
In the event of default on an unsecured loan, the lender has no automatic power to recoup their advance and they will need to engage in debt collection court proceedings, which can be costly and time consuming.
Verbal Agreement
Lending money in line with a verbal agreement only is extremely risky. Similar to an unsecured Loan Agreement, the only avenue available to seek repayment is via debt collection court proceedings, however a lender may be required to prove the advance of funds was a loan, as opposed to a gift, and this can be difficult without written evidence of an agreement to repay, which is why executing and securing your Loan Agreement is so important.
If you are considering lending funds to someone and would like to know more about securing your Loan Agreement, please contact our experienced staff on 03 5625 2544 or reception@wvblawyers.com.au, or book an appointment online, and a member of our Securities Team can assist to ensure your interests are appropriately protected before you transfer any money.
Authors:
Emily Farr – Lawyer and Keira Jarred – Paralegal
Disclaimer: The information in this post is general in nature. This does not constitute legal advice and should not be relied on as such. Please contact one of our Lawyers if you are seeking advice about a specific legal matter.
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