This post was first published on June 24, 2021, and was updated on March 30, 2023.
Buying property in Canada in 2023 is not for the faint of heart. Following eight consecutive Overnight Lending Rate hikes from the Bank of Canada over the last 12 months, the cost of borrowing has increased steeply, putting many mortgage borrowers under financial pressure.
Those with variable-rate mortgages have seen their monthly payments soar, or considerably less of their payment going toward their principal balance, in some cases even hitting their trigger rate. Fixed mortgages haven’t been immune, either. The bond market, which is highly sensitive to economic trends and inflation, has seen yields spike over the past year along with the Consumer Price Index, in turn increasing funding costs for lenders, which then pass them onto customers via higher fixed rates. In fact, a recent Ratehub.ca study finds that even though home prices have fallen year over year, these rising mortgage costs have outweighed any improvement in affordability.
As a result, Canadians may find themselves in a position where they don’t qualify for a traditional mortgage, or their buying power might have been reduced. For example, the most recent changes to the mortgage stress test in Canada – currently in the 6 - 8% range for most borrowers – caused Canadians to lose about 5% of their home buying power.
For many homebuyers, a 5% reduction in their purchasing power might represent a minor inconvenience or the need to lower their expectations regarding the home they can afford. However, for others, Canada’s tighter lending policies might prevent them from getting a mortgage from a traditional lender at all, especially if they have no credit or bad credit. In these cases, it’s common to consider other options beyond a conventional mortgage from one of Canada’s major lenders.
One of the most common alternatives to a traditional mortgage is a private mortgage, and this type of mortgage can be helpful to some borrowers. That said, a private mortgage has several pitfalls that should be carefully considered before you choose this option to buy your home.
What is a private mortgage?
In its simplest terms, a private mortgage is any mortgage from an individual or company that is not a federally regulated bank. Private mortgages could be from wealthy family members or other private individuals. Still, usually, they are offered by companies who have realized that the conservative lending guidelines used by banks and other federally regulated lenders exclude individuals. Private mortgages are typically interest-only mortgages with terms from one to three years, making them an option to bridge your financing until your financial situation improves and you can qualify for a traditional mortgage.
How is a private mortgage different from a traditional mortgage?
While applying for a private mortgage might sound like a good alternative to a traditional mortgage, the two financial tools differ in some fundamental ways. The most significant difference is the structure of the loan. When you apply for a traditional mortgage, you’ll qualify for a loan amount at a specific interest rate. You’ll make payments on your mortgage, and your payments will be a blend of the interest on the loan and the principal. Once your loan term expires (usually between one to five years), you’ll be left with a smaller mortgage principal balance and the option to either renew your mortgage or move to a new lender.
With a private mortgage, you’ll also qualify for a loan at a specific interest rate, but your payments will be interest only. At the end of your mortgage term (usually one to three years), you’ll have the same balance that you started with, and you’ll need to either renew your private mortgage or move your mortgage to another lender. Unfortunately, a private mortgage doesn’t allow you to pay down your mortgage, so you’ll never be mortgage-free.
Private lenders also use different qualification criteria to approve their borrowers. Traditional lenders focus on income and credit scores and have minimum requirements that are federally regulated. Private lenders focus more on your property’s value and type to determine whether to lend to you. They’ll also consider your income, down payment, and home equity if your mortgage is a refinance.
Finally, private mortgages are inherently riskier, so your mortgage interest rate will be higher, sometimes much higher, than a traditional mortgage. For example, while a traditional mortgage will typically have an interest rate in the low single digits, a private mortgage will have an interest rate ranging from 10-18%.
You’ll also pay a fee to use a private lender, usually 1-3% of your mortgage’s value. If you are applying for a larger mortgage, this can add up to thousands of dollars.
Pros and Cons of a private mortgage
Private mortgages have a unique set of pros and cons, unlike any other mortgage product. Here’s what you need to know about private mortgages:
- Different qualification criteria focus on property value
- Faster loan approval
- Specialized lending for unusual properties or incomes
- Flexible terms up to 35 years
- Higher interest rates between 10-18%
- Fees between 1-3%
- Interest-only payments mean no principal repayment
- Not federally regulated means reading the fine print is essential
Who should get a private mortgage?
Private mortgages aren’t for everyone, so who should get a private mortgage? Here are the circumstances where it is reasonable to get a private mortgage:
- Unconventional property purchase: If you plan to buy an unusual property, traditional lenders may not approve you for a mortgage, but some specialized private lenders might.
- Bad credit: If you’ve damaged your credit score in the past, a private lender will still issue you a mortgage. You can use that time to repair your credit and switch to a traditional lender.
- You have unconfirmable income: Small business owners or those with other sources of income may struggle to qualify for a traditional mortgage.
In all of the scenarios above, considering private mortgages will give you access to lenders that specialize in your unique financial circumstances, whether that be bad credit, a unique property, or unusual income sources. You’ll need to consider these private lenders carefully, evaluating their higher interest rates and fees, to determine if the choice is worthwhile.
Can I qualify for a private mortgage with bad credit?
One of the most significant reasons the average Canadian may consider a private lender is due to bad credit. To qualify for a traditional mortgage, you’ll need a credit score of at least 680. If your credit score is lower than that, you can either put off your house purchase until your credit score improves or consider other options like a co-signer or a private mortgage. Unfortunately, since Canada’s housing market is appreciating quickly, it may not seem like you have time to devote to improving your credit score, and a private mortgage might be an appealing option.
Suppose you are considering a private mortgage due to a poor credit score. In that case, you must confirm that you can make your monthly payments on your loan faithfully, as well as take the necessary steps to improve your credit score. These steps include paying all of your other debts faithfully, keeping a low balance on your credit cards, and maintaining a good credit mix. If you take out a private mortgage and can’t keep up with the payments, you’ll further damage your credit.
Should you ever get a private mortgage?
Private mortgages are a topic of conversation in Canada more than ever before, and at first glance, they might seem like a viable option. Ultimately, however, unless the circumstances preventing you from qualifying for a mortgage are temporary (for example, bad credit or unverifiable income), we don’t think that getting a private mortgage is a good idea. The high-interest rates and fees make servicing a private mortgage expensive. Most importantly, you won’t be paying down the loan principal, meaning you won’t build equity in your home or improve your financial situation.
The bottom line
If you are considering a private mortgage, you must have a real estate lawyer review the documentation to ensure you understand all associated fees and possible penalties. Remember, private mortgages are not federally regulated and the fine print may differ from a traditional mortgage.