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Understanding the Ins and Outs of Private Mortgages

A Look at Private Mortgages and Tips on How to Get a Private Mortgage

With more and more Canadians turning to private lenders to get a mortgage, there’s a lot of interest in the topic. But what exactly are private mortgages? And how do you go about getting one?

If you’re having trouble qualifying for a conventional mortgage from a bank, you may be better off looking into private mortgages to secure financing.

Read on to learn more about private mortgages and whether they are a good option for you.

What Is a Private Mortgage?

A private mortgage is a short-term interest-only loan from a private lender. These private mortgages only require that you pay the interest on the loan, not the principal, which reduces your monthly payments and frees up your cash flow.

But since you only pay the interest on this type of loan, you will not be any closer to paying off your debt when your mortgage term ends, so it is not an ideal long-term solution.

These are short-term solutions—usually one to three-year terms—for borrowing money to cover emergency expenses or improve credit.

Private mortgages are ideal for people who would otherwise have difficulty securing a mortgage from a traditional lender (bank or financial institution), such as those who:

  • Have poor credit scores due to a life event that was out of their control—e.g., illness, job loss, or death of a loved one;
  • Are non-residents;
  • Lack the income to qualify for a traditional mortgage—not steady or verifiable—e.g., self-employed, retired or using stated income;
  • Need quick approval for emergency funding—e.g., experiencing foreclosure or with income/property taxes in arrears;
  • Need a second mortgage for an investment property, home renovations, or to consolidate high-interest debt; or,
  • Want to buy unconventional property—such as a mobile home, micro-condo, vacant land, or a hobby farm—that otherwise may not be financed through a bank.

How Do Private Mortgages Work?

Private mortgage lenders will set maximum loan-to-value limits. In urban markets, private mortgages might be available up to 85% of the value of the home. In rural areas or specialty type properties, the loan to value is usually less.

To qualify for a private mortgage, private lenders typically require that you have a sufficient down payment or equity in your property. They are more flexible than traditional lenders when it comes to supporting documentation, such as proving your income, and your credit history.

Private mortgage lenders focus more on the value of the property, the down payment, and the borrower’s ability to repay the loan. And they tend to offer better rates for properties that are in desirable neighbourhoods and urban areas since they are considered lower risk in the event of a foreclosure. Urban properties are more marketable compared to properties in rural areas and undesirable neighbourhoods.

Understanding Mortgages: Private Lenders Vs. Big Banks

The interest rates on private mortgages tend to be higher than with traditional mortgages since these mortgages are considered a higher risk for lenders. Interest rates can range from 6% to 18%, which is much higher than traditional mortgage rates that are usually 2.5% to 5%.

There are also additional fees associated with private mortgages, such as lender, legal, and broker fees. These additional fees may be rolled into the mortgage.

Private mortgages are often fully open or have a three-month interest penalty to break them so that you have the option to pay them off in full or break your mortgage any time.

Who Can Lend Money for a Private Mortgage?

Private mortgage lenders are individuals or organizations who invest their capital for short terms to make a profit from private mortgage loans. Some private lenders prefer to invest in residential mortgages while others prefer commercial properties or properties in a specific region, such as close to their primary residences or operations.

Private lenders are often:

  • Individuals who lend personal funds to gain a return;
  • A syndicate group of investors who pool funds that are invested on a case-by-case basis; or,
  • Mortgage investment corporations who pool capital from investors or individual lenders for several loans at once if the deals meet lending guidelines.

Are Private Lenders Regulated?

Private mortgage lenders are not regulated, so you have to make sure you’re working with a reputable lender. The best way to do this is by first working with a knowledgeable and well-connected mortgage broker. A mortgage broker will also be able to tell you how flexible the lender is.

Some lenders are stringent and will force a foreclosure or power-of-sale if you default on a mortgage payment. And others are more flexible and will work out arrangements to help you keep your home if you default on a payment.

What Do I Need to Watch Out For?

Read the contract from a private lender thoroughly so you understand the terms. One dangerous term that can be slipped into mortgage contracts is the bona fide sale clause. This clause makes it so that the only way you can break your mortgage is by selling your home.

Also, research the reputation of potential lenders online. Some lenders you’ll want to avoid might be involved in court cases, fighting borrowers for money.

How Do Private Mortgages Impact Credit?

A private mortgage gives the borrower an opportunity to demonstrate a positive repayment history, which the borrower wouldn’t be able to demonstrate otherwise if ineligible for a mortgage from a bank.

However, since private mortgage lenders do not usually report to the credit bureau, a private mortgage alone will not likely help increase your credit score. At the same time, some lenders may ask to see bank records going back 12 months to see if you have made your private mortgage payments on time, which is good for your repayment history but won’t impact your credit score.

Often, a private mortgage is used to pay out unsecured credit card debt which means if you have no balance on your credit card, it shows the credit reporting agency (Equifax and TransUnion) you are good at managing money and your credit score will go up. At the same time, if you have poor credit, sometimes the banking institutions want to close your credit cards once they get paid off. Or perhaps your credit score is so poor that when you get a private mortgage, you already have no active credit.

Navigating the Changing Mortgage Market

If this is the case, then a great way to improve credit is by getting a secured credit card. A secured credit card is when you give a financial institution money, say $2,000, and then they give you a credit card with that limit. Once you have used it for a little while, and so long as you have made the required payments and that your balance is not hugging the limit of the credit card, then your credit score will increase.

Borrowers are encouraged to have at least two active credit items as this is usually a requirement for lenders to offer you the best rates and terms when applying for a mortgage.

How A Mortgage Broker Can Help You

Mortgage brokers can help you weigh your options when it comes to borrowing a mortgage. They are your go-to resource for finding a mortgage solution that is best for you and your financial situation.

A mortgage broker will connect you with a reliable private lender and help you with the private mortgage contract.

Questions to Ask Your Mortgage Broker

Mortgage brokers will also help you address and rectify any issues that are preventing you from qualifying for a traditional mortgage. And they will help you create a plan—known as an exit strategy—to move from a private mortgage to a traditional mortgage once you are ready.

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