Why Private Loan Rates Are Higher Than Bank Rates

Key takeaways

• Banks fund from cheap retail deposits; private lenders fund from investors who expect a return.
• Private lenders take the deals bank policy declines, which prices the risk higher.
• Speed has a cost: capital must sit ready to deploy in days.
• The premium is usually temporary - most private loans are refinanced out.

It starts with where the money comes from

A bank lends money that depositors have placed with it, paying those depositors a modest rate and holding an authorised deposit-taking institution licence with the prudential obligations that come with it. A private lender has no deposits. It lends investor money, and those investors could put their capital elsewhere, so they require a return that reflects the risk they are taking.

That funding cost sets the floor. A lender whose investors expect a return in the high single digits or better simply cannot write a loan at bank pricing - there would be nothing left to pay the investors, let alone run the business.

This is why comparing a private rate to a bank rate is comparing two different products. One is deposit-funded, prudentially regulated, slow and policy-bound. The other is investor-funded, flexible and fast.

The risk is genuinely different

Private lenders are, by definition, looking at deals a bank has declined or cannot move on in time. That population has a higher loss rate, and pricing has to cover it across the book.

• Security a bank will not take - part-built projects, specialised assets, rural land, second mortgages.
• Borrowers who cannot evidence income conventionally - unlodged returns, recent self-employment, complex structures.
• Timeframes that preclude a full credit process - settlements measured in days.
• Situations under pressure - a deadline, a distressed sale, a facility being called.

Lower LVRs offset some of that, which is why private lenders cap advances well below bank levels. The equity buffer is the protection, and the rate covers what the buffer does not.

Speed is not free

Settling in days requires capital sitting ready to deploy, a credit decision made by people rather than a scorecard, and lawyers instructed immediately. Money that is held available to move quickly earns nothing while it waits, and that idle cost is priced into every loan that does get written.

It is worth being concrete about what speed is worth. If a private loan costs $30,000 more than a bank loan over six months but secures a purchase you would otherwise lose, the comparison is not against the bank loan - it is against not doing the deal.

Which points at the right way to use private lending: as a bridge with a defined exit, not a permanent arrangement. Most private loans are written to be refinanced out to a bank once the reason for urgency has passed.

Frequently asked questions

Are private lenders just expensive banks?

No - they are a different product. Banks are deposit-funded and prudentially regulated, which makes them cheap and slow with a fixed credit policy. Private lenders are investor-funded, which makes them expensive and fast with policy set deal by deal.

Will the rate come down if my situation improves?

Not on the existing facility, which is priced for its term. The usual path is to refinance to cheaper funding once you can evidence income conventionally or the project reaches a stage a bank will lend against.

Does a lower LVR get me a better rate?

Generally yes. LVR is the main pricing lever in private lending because the equity buffer is what protects the lender. Reducing the loan amount often moves pricing more than negotiating does.

Related reading

• What Private Lending Actually Costs in Australia
• Private Loan Fees: Establishment, Brokerage and Exit Costs
• Small Business Line of Credit: How It Works and When to Use One

Sources

• Chart pack - lending rates — Reserve Bank of Australia
• Moneysmart - types of lenders — ASIC