Private Mortgage Loans
What is a private mortgage in Canada?
For borrowers who can’t qualify for a mortgage loan from a traditional A or B mortgage lender, getting a private mortgage may be a solution. Private mortgages are a type of home loan that is provided by an individual financer or group of investors. They are typically meant to be a short-term solution, ranging in length from one to three years. A key difference with private mortgages is that they are often interest-only loans, meaning the borrower will only make interest payments over the life of the loan, without any going toward the mortgage’s principal balance. At the end of the private mortgage term, the borrower will still owe the principal balance in full.
Due to these higher interest rates and overall riskier features, private mortgages are not for everyone. However, they provide an alternative for borrowers who can’t satisfy the conservative lending guidelines used by financial institutions. These guidelines are in place to ensure borrowers are in the financial position to repay their mortgages, and are based on income, debt requirements and credit health. These are important underwriting standards that protect lenders from issuing high-risk debt – but they can exclude many individuals who are, in fact, able to pay back their mortgage loan, but have an extenuating circumstance such as being self-employed or having a low credit score.
Private lenders will look beyond this traditional borrowing criteria and, most importantly, will take into account a property’s overall value and marketability as opposed to simply the borrower’s credit history. Borrowers with a credit score under 600 are likely to be turned down by a prime or bad credit lender, for example, and may need to turn to a private lender. Because private mortgage lenders are willing to work with borrowers with bruised credit – and are often the fastest financing option – the trade-off is that interest rates are almost higher than a traditional mortgage, along with extra fees, and potentially fewer protections for borrowers.
Why do people get private mortgages?
You would use a private mortgage under any of the following circumstances:
- You want to purchase an unconventional property that a prime lender or bank won’t finance.
- You need fast financing and don’t want to wait for a long approval process.
- Your bad credit history means you are being turned down by conventional lenders.
- You only need a short-term loan.
- You have non-confirmable income that is preventing you from obtaining a traditional mortgage.
Also read: Should you get a private mortgage?
What is the difference between a private mortgage and a bank mortgage?
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Calculating interest on a private mortgage
Using a sample private mortgage loan, let’s assume a homeowner needed to borrow $400,000 at 8% interest on a two-year term. We would then want to calculate the monthly payments and total interest over the term as follows:
Step 1 : Calculate monthly payment
8% (annual interest rate)
÷ 12 (months in a year)
= Monthly interest rate: 0.66%
0.66% (monthly interest rate)
x $400,000 mortgage amount
= Monthly interest payment: $2,667
Step 2 : Calculate interest over term
$2,667 (monthly interest payment)
x 12 (months in a year)
x 2 (years in term)
= Monthly interest rate: $64,000
By the end of the two-year term, the borrower would have paid $64,000 in interest, and would still owe their lender the original $400,000 principal loan amount.
Are private mortgages more expensive?
Private mortgage interest rates can range from 10-18% depending on the property, borrower and current economic conditions. Since they are almost always higher than rates offered by conventional mortgage lenders, you would only turn to a private lender when turned down by banks and bad credit lenders such as HomeTrust.
Rates depend on the source of funding. If, for example, a private lender is funded by a mortgage investment corporation (MIC), then they will want to make a solid rate of return for their investors.
Fees associated with a private mortgage loan
With a prime or conventional lender, the broker is paid a commission directly from the lender. When using a private lender, you (the borrower) pay the broker’s fee directly. Private loans also incur set-up fees, bringing total fees paid between 1-3% of the loan amount.
The good news is, these fees can be financed through the mortgage loan. Let’s say you need to borrow $100,000, and can therefore expect fees of $3,000 ($100,000 * 3%). In order to cover these fees, you would apply for a loan of $103,000 to cover the extra costs.
Private mortgage lenders specialize
Private lenders will often specialize in a certain lending category. Some examples include:
- Commercial vs. residential: Private lenders will generally specialize within a property type to focus investment.
- Refinance for debt consolidation vs. renovation etc.: Lenders will sometimes specialize based on the reason for seeking a mortgage loan. Some lenders may only provide funds to those who are refinancing with the intention of purchasing another property.
- Prefer urban areas: Large urban centres are more appealing to private lenders, as these areas carry more real estate value.
- Often prefer the region they live in: Lenders are most comfortable investing in the area they live in, as they can personally evaluate the property. However, this is not always the case.
What time frame can I expect with a private loan?
Approval usually takes place within one week of application and can be as soon as a couple of days. The processing of the loan and the release of funding takes around two to three weeks.
Private mortgage lenders want their clients to be able to transfer on to a prime lender within one year to 18 months. They deal in fast financing and therefore need to be able to collect their return on investment within the specified time. As such, a private lender will try to help the client move on to a prime lender, which is also in the client’s best interest.
What criteria will they look at?
More so than prime or conventional lenders, private lenders have tighter guidelines on other factors to compensate for the added risk.
- Property type and value. This is arguably the most important factor in being approved by a private lender. The mortgaged property must be in good condition and will have to undergo a strict appraisal before you are approved. If you have a poor credit score, you are considered a riskier client and lenders need to ensure that their investment is secure in case you default on your mortgage.
- Income. Your income can fall into one of two categories: confirmable and non-confirmable income. Confirmable income is preferred by lenders, and is proven through Notice of Assessments (NOAs). Non-confirmable income, common among self-employed or commission-based employees, forces lenders to use an estimate of your income based on the average income typical of your employment.
- Down payment (if purchasing). With a private mortgage lender, the minimum loan-to-value ratio on the property is 85%. That is, you need to put in a down payment of at least 15% to be approved. If you can afford to put in a higher down payment, then it is advisable to do so. A larger down payment means you have more funds invested in the property and that you have more at stake. Lenders also take this as a sign that you can keep track of your personal finances.
- Equity (if refinancing). If you are refinancing, private lenders may allow you to go up to a maximum of 85% in loan-to-value. For example, if your property is valued at $400,000, you can refinance up to $340,000. Many private lenders prefer a maximum LTV of 75%, especially in British Columbia. With respect to a minimum equity stake in your property, there is none.
What if I have a collateral-charged mortgage?
If you’ve signed up for a collateral mortgage with a bank, you’ve essentially pledged all your equity to that bank. Consequently, it makes it almost impossible for another lender, even a private lender, to refinance your property, provide a second mortgage or even for you to switch lenders at the time of your renewal.
A good mortgage broker can help connect you to the right private mortgage lender. With a private lender, the broker’s commission isn’t included in the loan amount, so your broker will charge you a small upfront fee. Despite the charge, it may be worth it to find a lender who can provide you with the lowest mortgage rate for your financial needs.
In summary, the principal difference between prime lenders and private mortgage lenders is that private lenders consider unique properties based on a borrower’s ability to pay back a loan, not just on credit history. Every client is evaluated on an individual basis taking into account the points mentioned above.