When You Should Consider a Private Mortgage
As a prospective homeowner, you may have heard of the term private mortgage and wondered what exactly differentiates a private mortgage from other mortgages. When it comes to finding a mortgage, there are just as many mortgage products out there to consider as there are lenders to provide you with one.
While a traditional mortgage is usually the first choice of homebuyers, there are often instances where that option might not accessible or available to you. In those cases, you may have to approach private mortgage lenders in order to get your mortgage.
A private mortgage is a short-term, interest-only loan that is provided by an individual, group, institution or business that is not a major bank or credit union. In some cases, a private lender can even be someone you know, such as a friend or relative. Private mortgages have terms that are much shorter than traditional mortgage terms, usually ranging from six months to three years. As they are interest-only loans, they do not require the principal to be paid down and instead require monthly interest payments.
Unlike traditional lenders, private mortgage lenders tend to offer more freedom and less restrictions for borrowers. While banks are often more exclusive and selective with who they provide mortgages to, private mortgage lenders are more open-minded and place more consideration on a property’s value as opposed to a prospective client’s credit history.
When applying for a traditional mortgage, the lender will request and review your full credit history. If your credit is bad – or non-existent – the lender may reject the application. However, when you apply for a mortgage with a private lender in Canada, they often require less documentation which can lead to faster approval even if you have bad credit. If you can provide the private funding source with a well-defined plan that demonstrates how the money will be used and how it will be repaid, you will increase your chances of getting approved.
Although obtaining a mortgage loan through the private lending network is often easier than getting approved for a traditional mortgage, there are some risks involved. For example, if you fail to make your payments on time, the private lender will foreclose on your home.
If you are working with a mortgage broker and have not paid off your mortgage when the term expires, they will help you convert your private mortgage to a traditional mortgage. As a result, many borrowers integrate a move to a traditional lending source into their plans when they apply for private mortgage loans.
There are several situations that might influence your decision to approach a private mortgage lender to get financing for a home purchase. These situations include:
- Rejection from traditional lenders due to bad credit
- Being self-employed with no steady source of income
- Being a newly-landed immigrant with limited or no credit history
- The need for quick or emergency funding for a shorter period of time
- The need for a second or third mortgage (generally for investment properties)
- Obtaining financing for a smaller, non-traditional dwelling that cannot be financed or refinanced through a bank (such as a micro condo or a mobile home)
Before you approach a private lender, you should consult with your mortgage broker. Not only can they explain how the private lending process works, they may also have connections to private lenders who can assist you.
Unlike traditional mortgages, where you complete a formal application which involves a credit check, confirmation of employment and subsequent approval (or rejection) from the lender, private mortgages are generally arranged through a mortgage broker. If you have been rejected by one or more banks or credit unions, your next step is to consult your mortgage broker, who can help you tap into the private lending market.
Qualifying for a mortgage from a private lender is often much easier than qualifying for a mortgage from a traditional source. Banks and credit unions have very strict requirements centred on credit, income and employment. Even if you prove that you will be able to pay off the mortgage, they may still reject you because you fail to meet one or more of their other qualifications.
Private lenders view mortgages as an investment opportunity. They are less concerned with your credit history and more concerned with the value of your property, your down payment and how you intend to repay the loan you are provided.
There are several differences between traditional and private mortgages.
1. Interest rate
One significant difference is the interest rates. On average, the interest rates for private mortgages in Canada range from 8-18%; this varies based on the lender and your circumstances. These are noticeably higher than interest rates for traditional mortgages, which tend to hover around 2.5 to 5%, depending on the type of mortgage product and the lender.
2. Down payment
Another difference is the down payment. Private lenders will typically require a minimum down payment of at least 15% – for an 85% loan-to-value ratio – or higher depending on your individual situation as well as the type of property you’re financing. Because private lenders place emphasis on the value of the subject property over the borrower, they want to be adequately protected, should things go awry.
3. Length of the term
A third difference is the length of the term. Traditional mortgages usually have terms lasting up to 10 years, while private mortgage terms can range from six months to three years, depending upon the lender and your personal needs at the time.
4. Type of property
If you have a standard single-family home or multifamily property that does not require extensive renovation, a traditional mortgage is your best bet. But if you own a non-traditional residential property, such as a micro condo or mobile home, approaching a private lender may be your only option. This is because banks only provide mortgage loans for traditional properties.
5. Type of client
Traditional mortgage loans are provided to homeowners who plan to live in their homes. Private mortgages are usually obtained by real estate investors who purchase properties with the intention of renovating and flipping them for profit. As many fix-and-flip operations can be completed in short order, the shorter terms associated with private mortgage lending make them more attractive to property investors. These shorter terms are also one of the main reasons why private mortgages have higher interest rates.
Private lending may also be your only choice if you are unable to obtain financing from a traditional lender due to bad credit or if your financial situation changed drastically due to divorce, loss of income or other unforeseen situations.
6. Payment structure
With a traditional mortgage, if your principal has not been paid off by the time your term ends, you can renew it with your current lender or move it to a different one. You will then continue making monthly payments until the principal is finally paid off.
In a private lending scenario, the exit strategy is more concrete in its structure. Because of the shorter term, private mortgages are usually paid back in full by the time the term is up. For investors, a six-month to three-year term is a sufficient amount of time for a property to be renovated and resold. In bad credit scenarios, the goal is to move the client to a traditional mortgage with a better rate once the term ends. Unlike traditional mortgages, where your monthly payments go directly towards paying off the principal, private mortgages are interest-only loans and only require monthly interest payments as a result.
The only instances where you may have to deal with fees are legal fees if you have a collateral mortgage or administrative fees when your term expires and you choose to transfer your mortgage to a new lender instead of renewing with your current one.
Private mortgages usually have several fees involved. These include legal fees, loan processing fees, appraisal fees, and broker fees if arranged with the assistance of a mortgage broker.
If you are unable to obtain a mortgage through traditional means, your credit is not up to par, you are purchasing a non-standard property or you are looking to renovate and resell a property quickly, approaching a private lender may be your only option. Bear in mind that even though private lenders have faster approval rates, their interest rates are much higher than those of traditional mortgages. There are also numerous fees involved with obtaining a mortgage through private funding.
Although it is easier to obtain short-term financing through the private lending market, it is also somewhat risky. Aside from the higher interest rates, private lenders can foreclose on your home faster if you fall behind on making your payments.
In the end, it’s up to you to decide whether you’d like to go the private or traditional route for your mortgage. Although there are some risks involved, many Canadians are tapping into the private mortgage lending market, and it’s a good backup plan to have if you are having difficulty getting the financing you need for a home.
If you decide to get private financing, be sure to consult your mortgage broker first, as they can help point you in the right direction.