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Investing In Residential Mortgages

John Bolton looks at the new-build Government tax exemption in more detail and shares his pointers with investors.

By: John Bolton

1 July 2021

At Squirrel we are one of the largest mortgage brokers in New Zealand having settled over $1.5 billion of mortgages in the last year. We are also a lender, which means we can make a portion of those loans available as investments for retail investors. This gives retail investors better investment opportunities for their cash funds.

It is an alternative investment for your cash when it’s not tied up in property, and it is more liquid than property. For investors you get the advantage of relatively high interest rates on cash funds. We currently pay retail investors either 4% or 5% pa depending on the risk appetite – paid monthly. The investment is secured over loans that are backed by first-mortgage residential security at a maximum loan to value ratio of 80%.

The investments are held on trust by a trustee and are specifically into the investment classes you choose. The credit risk of the loans dictates the returns available. Floating rate home loan investments are offered at 4% pa, and floating rate residential construction loan investments are offered at 5% pa.

As property investors you will appreciate the security that residential property provides, especially where lending is below 80% of the value.

Mortgagee sales are rare in New Zealand as distressed borrowers can usually sell their property before it gets to that point. In the event of a mortgagee sale, the proceeds are used to repay investors. If there is a shortfall it is covered by our reserve funds, and if that falls short, then we replenish the reserve fund by shaving off a portion of the interest otherwise payable to investors.

Investor capital is supported by the mortgage over the residential property, a reserve fund, and then socialising any residual loss by reducing the interest paid to investors.

What Is The Risk Of Loss?

We don’t have much in the way of mortgage investments in New Zealand to analyse, but in Australia over $100 billion of mortgage securities have been issued with no investor losses. The expected loss rate on a residential mortgage security portfolio sits between 0.05% and 0.3% (one third of 1%). To put that in perspective, that doesn’t even come close to eating into investor returns.

In Australia mortgage insurers provide a similar risk product and the maximum default rate reported was 1.5% after the 1987 share market crash.

Higher Risk And Return

Squirrel also offers a 5% deposit home loan for first home buyers called Launchpad. From an investor perspective, part of this loan sits in our personal loan portfolio, not our home loan book. With this product investors receive 7.5% pa and these investments are supported by around $600,000 of reserves. These investments have higher credit risk with a second mortgage as security. Investors fund up to 15% of the home loan so it is a smaller exposure and because the loans are a lot smaller (circa $100,000), the credit risk is quickly diversified across our personal loan portfolio.

We currently have over 4% of the active loan book in the reserve fund for the personal loans and our reserving rate currently averages circa 2% pa for the life of those loans to cover expected credit losses. Thanks to our reserve fund model, in the 5.5 years the Squirrel platform has been running, our investors have never missed an interest payment, and we intend to keep it that way.

Access To Your Money

Squirrel’s marketplace allows you to transfer your investments to other investors, freeing up the cash. This feature is available at no cost to the seller or buyer of an investment. While it isn’t guaranteed that we’ll find another investor to pick up your investment, our track record shows most investors have gotten their cash out within a few weeks of listing.

In addition, because loans are repaying regularly there are generally plenty of investors wanting to reinvest.

Since launching our peer-to-peer platform we have settled around $130 million of loans and no investor has lost a cent of capital or interest. However, as with any investment, past performance is no guarantee of future performance.

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