What is a private mortgage and when does it make sense?
For those having trouble qualifying for a traditional mortgage, other solutions are still available, one of which is a private mortgage.
And with increasingly stricter mortgage regulations and qualification requirements being introduced by the government, they’re growing in popularity.
Private lending accounted for approximately 4-5% of Canada’s overall mortgage market in 2015, according to data from Teranet. Anecdotally today’s number is higher and growing fast, and is set to grow even faster if the new B-20 guidelines are implemented as proposed.
“What makes interest only loans appealing is that you are not required to pay down the principal of your mortgage, therefore reducing your monthly payment,” said Maya Schenk, managing broker and owner of Pacific Lending in Vancouver. “Interest-only payments improve the monthly cash flow, but for obvious reasons they are not a viable long term solution.”
This is why private mortgages are meant to be short-term solutions—typically one to three years—to help borrowers achieve their goals while they improve their credit, or for emergency lending situations.
Private mortgages have their place in the market, and are commonly used in some of the following cases:
Borrowers with inadequate credit to qualify for a traditional bank mortgage
Self-employed borrowers with unverifiable or unsteady income
Emergency funding for those going through foreclosure, or those with property/income taxes in arrears
For mobile homes or micro-condos (less than 600 square feet) that often can’t be financed/refinanced through a bank
For second mortgages/investment properties
In terms of the key benefits of a private mortgage, Schenk cites the need for less documentation as part of the approval process, which he says can be useful for self-employed applicants who can have difficulty proving their income.
“Private lenders are also much more flexible when it comes to your credit history,” she said. “As long as you have sufficient down payment or equity in your property, private mortgages are relatively quick and simple to obtain.”
While traditional bank mortgages are qualified primarily on the borrower’s financial standing and his or her ability to service the debt, private lenders place more weight on the quality of the property itself, in addition to the down payment and the client’s ability to repay to loan.
Because properties in more marketable urban areas carry less risk for the lender in the event of foreclosure, they can offer slightly more favourable rates and go up to a higher loan-to-value compared to properties in rural areas or undesirable neighbourhoods.
The higher cost of private mortgages
Schenk notes that in addition to the interest-only payments, private mortgages typically come with higher interest rates to compensate the lender for the increased risk they are taking on.
Interest rates can range anywhere from 10-18%, making them much more costly compared to a traditional prime mortgage starting as low as 2.50% for a 5-year fixed term. For this reason private mortgages are usually considered a last resort.
Additional fees can be involved with private financing, including lender, legal and broker fees.
Whereas broker fees are almost always paid as a commission directly by the lender in the case of traditional mortgages, the borrower must cover this cost when turning to a private mortgage.
Adding in lender fees and legal costs, total fees can amount to anywhere from 1-4% of the loan amount, though this can be rolled into the mortgage.
“It is important to understand the risks before getting a private loan,” Schenk adds. “The first questions to ask yourself are, ‘Will my financial situation change in the near future so that I can switch to a conventional lender soon?’ and ‘Will I need this mortgage only for a short period of time?’ If your answer is ‘no’ to both of these questions, private mortgage might not be a suitable solution.”
For anyone considering a private loan, a mortgage broker can help weigh the benefits against the costs to determine if one is right for you.
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