Thinking about putting your money into property-backed lending?
Here’s something most investors don’t realise until it’s too late…
All loans are not the same. You can have two loans on the same property making almost identical interest payments and have one loan that is riskier than the other.
It all comes down to one simple question:
Who gets paid first?
Here’s the risk ladder. And when you know about it, you’ll invest your money much more wisely. Particularly when considering a pooled mortgage fund.
Here’s What’s Inside:
- What Is A First Mortgage?
- What Is A Second Mortgage?
- The Risk Ladder Explained
- Why This Matters Right Now
- How A Pooled Mortgage Fund Fits In
What Is A First Mortgage?
A first mortgage refers to the primary loan on a property. It is recorded first against the title allowing the lender to be first in line if needed.
Simple, right?
In the event of a borrower defaulting, when the property is sold the proceeds from the sale are used to pay off the first mortgage holder. Only after the first mortgage is satisfied will any remaining funds be used to pay off subordinate lenders.
That’s why first mortgages sit on the safest rung of the ladder.
Lenders also limit the percentage of the property value that they’ll lend. This is known as the loan-to-value ratio (LVR). If a first mortgage is at 65% LVR, the property could fall over a third in value before the lender’s money is at risk.
That buffer is everything.
That’s also why so many investors insist on finding a pooled mortgage fund that lends predominantly in first position. If you’re shortlisting what the best mortgage fund australia has to offer, start by looking at how much of their pooled loan book is backed by first mortgages. The bigger that percentage is, the safer your capital will be.
What Is A Second Mortgage?
A second mortgage refers to any loan which is secondary to the first loan on the same property. Second mortgages are also referred to as “junior” or “subordinated” loans.
Here’s the problem:
The second lender doesn’t get paid until the first lender is paid off completely. If the property sells for less than expected, the second lender could receive part of their funds back…
Or none at all.
So why would anyone lend on a second mortgage?
Higher returns. The risk is greater so the interest paid is greater. Second mortgages are often used to supplement funding when a first lender won’t stretch any further. Developers use second mortgages to bridge bank loans and their own equity.
That spread is where the additional return is earned. That’s also where the additional risk resides.
The Risk Ladder Explained
Property-backed lending can be thought of as a ladder. The higher you climb, the more you can make… but, the further you can fall.
Here’s how the rungs usually stack up:
- First mortgage: first in line, lowest risk, lowest return
- Second mortgage: second in line, higher risk, higher return
- Equity: last in line, highest risk, highest potential return
Now here’s a quick example to make it real.
Okay, say there’s a property worth $1 million. There is a first mortgage for $600,000 and a second mortgage for $200,000. The market drops and someone buys the property for $700,000.
First lender is repaid the full $600,000. Second lender only recovers $100,000 of their $200,000. Owner receives nothing.
Same property. Same sale. Totally different outcomes.
Position matters more than the interest rate.
A 12% return sounds impressive in writing. But if you’re last in line when the music stops, the numbers don’t matter.
Why This Matters Right Now
Property-backed lending isn’t a small corner of the market anymore.
Australian private credit has boomed over recent years with real estate representing about half of it, according to estimates by ASIC of a $200bn market. That’s around A$100 billion…
And not all of it sits in first position.
Regulators have taken notice as well. ASIC scrutinised private credit funds lending to property. It highlighted problems such as opaque fees, poor valuations and lending to related party developers.
Here’s some history to understand why this is important. In 2012, private non-bank property lender Banksia Securities collapsed while owing $663 million to approximately 15,622 debenture holders.
That’s not intended to frighten you away from real estate lending. It’s intended to illustrate for you why you need to know precisely where your money is on the ladder.
How A Pooled Mortgage Fund Fits In
A pooled mortgage fund aggregates capital from many investors and uses it to invest in numerous mortgage loans secured by property. Rather than investing in an individual loan, you own a proportion of the entire pool.
Think about it:
If something happens to one borrower, it’s just one loan out of many. The rest of the pool continues to pay interest. That diversification is one of the primary advantages of a pooled mortgage fund.
But here’s the catch…
Pools differ. Some pools don’t deviate much from first mortgages and conservative LVR’s. Others employ second mortgages and construction loans in the pursuit of greater yield. Both types can label themselves a “mortgage fund” in the brochure.
That’s why you need to look under the bonnet.
Questions To Ask Before You Invest
Ask these questions before you invest one dollar in a pooled mortgage fund:
- What percentage of loans are first mortgages?
- What’s the average LVR across the pool?
- How are properties valued, and by who?
- Are there any loans to related parties?
- How often will you get a full investor report?
- How easy is it to withdraw your money?
An ethical fund manager will respond to each of these questions without flinching. If the answers are murky or difficult to locate, consider that a warning sign.
Climbing The Ladder The Smart Way
First mortgages and second mortgages can both be involved in property-backed lending. It’s important to know which rung you’re on.
To quickly recap:
- First mortgages get paid first and carry the lowest risk
- Second mortgages pay more because they get paid last
- LVR is your safety buffer, so the lower the better
- A pooled mortgage fund spreads risk across many loans
- Always check what’s actually inside the pool
Higher returns look tempting. In property lending, capital preservation comes first. Know the ladder. Ask the right questions and you’ll be far better placed to grow your wealth with confidence.
Wandaneliah Kilgore writes the kind of expert financial advice content that people actually send to each other. Not because it's flashy or controversial, but because it's the sort of thing where you read it and immediately think of three people who need to see it. Wandaneliah has a talent for identifying the questions that a lot of people have but haven't quite figured out how to articulate yet — and then answering them properly.
They covers a lot of ground: Expert Financial Advice, Capital Markets Updates, Personal Finance Insights, and plenty of adjacent territory that doesn't always get treated with the same seriousness. The consistency across all of it is a certain kind of respect for the reader. Wandaneliah doesn't assume people are stupid, and they doesn't assume they know everything either. They writes for someone who is genuinely trying to figure something out — because that's usually who's actually reading. That assumption shapes everything from how they structures an explanation to how much background they includes before getting to the point.
Beyond the practical stuff, there's something in Wandaneliah's writing that reflects a real investment in the subject — not performed enthusiasm, but the kind of sustained interest that produces insight over time. They has been paying attention to expert financial advice long enough that they notices things a more casual observer would miss. That depth shows up in the work in ways that are hard to fake.
