Reasons to Consider a Private Mortgage When Recovering from Poor Credit
If you’ve ever gone through the process of getting approved for a mortgage with a financial institution, you know that the better your credit score, the better your chances are of getting a good mortgage rate. And if your credit score is below a certain threshold, banks won’t qualify you at all.
But what if you have bruised credit – what options do you have to help increase your credit score while maintaining a mortgage? That’s where private lenders come in.
Private Mortgage Vs. Institutional Bank Mortgage – And How Each Affects Your Credit
While the traditional institutional bank mortgage allows you to secure a loan from a bank, with a private mortgage, the money is sourced from a private lender such as an individual or business.
Both types of mortgages can boost your credit in different ways.
With an institutional bank mortgage, you may see a boost in your credit score as long as you are able to make all of your monthly payments.
A mortgage can also diversify your credit, which will help improve your score.
Private mortgages are an alternative option for prospective homebuyers or homeowners who have been unable to secure a mortgage the traditional way through a bank or financial institution.
They are also a good option if you require funds to help with any of the following:
- Pay off or consolidate debts
- Renovate your home
- Supplement your first mortgage
- Pay off debts to CRA or pay property taxes
In these cases, a private mortgage can be like a short-term lifeline for borrowers unable to access other sources of funding.
However, since private lenders do not report to the credit bureau, a private mortgage alone will not improve your credit score.
But if used correctly, a private mortgage can buy you enough time to repair your credit yourself.
If you have secured a private mortgage to pay off unsecured credit debt, this will show the credit reporting agency that you are good at managing money, which will help improve your credit score.
Here is an example. Let’s say you want to sell your home for $350,000 and buy a new home for $450,000.
While you may have good credit and have never missed any payments, if all of your credit items are maxed out, you will not qualify for the best rates and terms.
But by securing a private second mortgage behind the first bank mortgage, this will provide you with enough money to pay off unsecured debts including credit cards, lines of credit, student loans, and car loans.
Once all these items are paid off, your credit score will increase. And when you decide to sell your home and buy a new one, you will be able to qualify for best rates on a new mortgage.
At the same time, in some cases where borrowers have poor credit, banking institutions may want to close your credit cards once they are paid off. Or, perhaps your credit score is so poor that you have no active credit when you get a private mortgage.
A great way to improve credit in these cases is by getting a secured credit card. A secured credit card requires you to put down a deposit as collateral in exchange for credit.
After using it for a little while, making all your required payments on time, and ensuring the balance is not hugging the limit of the credit card, your credit score will increase.
Why Would You Turn to a Private Mortgage?
With housing prices surging in almost every major Canadian City, and banks implementing tighter restrictions on borrowing, securing a mortgage is no longer an easy feat, especially for first-time homebuyers.
As a result, many people looking to buy a home are turning to private mortgage lenders for help.
The reason for this is that private lenders are not as strict as banks when it comes to lending money and have more discretion and flexibility regarding their lending guidelines.
These lenders are often individuals lending their own money or a small group of investors who can make their own rules and restrictions.
So, because they are not required to follow the same rules as banks, they are able and more willing to offer loans in high-risk situations.
What Are Private Mortgages Commonly Used For?
Private mortgages are most often used as a solution for the following types of people.
Borrowers with Bruised Credit
If your credit score has taken a hit for one reason or another, securing a mortgage from a bank will not be easy.
But with a private mortgage, lenders often prioritize a property’s value and marketability rather than your credit history, making it easier to secure this type of mortgage with poor credit.
Borrowers Who Are Self Employed
Private mortgages can be a great option for people who are self-employed and struggling to get approved for a traditional mortgage.
Many banks and financial institutions can be wary about lending money to people who are self-employed, as their income can be considered unstable and unpredictable. Private lenders often look past this and are more likely to lend to self-employed borrowers.
Second Mortgages or Investment Properties
A second mortgage can help with consolidating debt, funding home renovations, providing working capital, or paying for other large expenses. However, individuals in these types of situations often have a hard time securing funds through a bank.
Pay Off Debts
For people with large piles of debt they are struggling to pay off, consolidating your debt into an existing first mortgage through you bank is one solution that can help you stay afloat while paying down debt.
But if you don’t meet the minimum lending requirements and have missed any of your debt payments, turning to a private lender may be your only option.
What Factors Do Private Lenders Consider When Approving a Private Mortgage?
While credit score is often overlooked by private lenders, there are still several factors that they consider when deciding who to lend to. Here are some examples of criteria that most private lenders will look at.
Property Type and Value
This is one of the most important considerations for private lenders when it comes to securing a mortgage. In fact, lenders will require the property to be in good condition and undergo a strict appraisal before you can secure a private mortgage.
Private lenders will place borrowers into two categories: confirmable and non-confirmable income.
Confirmable income means you have a regular steady income with an amount that can be confirmed.
Non-confirmable income is considered higher risk and is common amongst people that are self-employed or work jobs where their income varies.
However, regardless of which category you fall into, as long as it makes sense to the lender, you are likely to be approved for a private mortgage.
For example, if you are a dog walker and you indicate that you make $250,000 a year in cash, that is probably pretty unlikely. However, if you are a taxi driver or server and you make $70,000 per year, this would make more sense and a private lender would likely be happy to consider this income to justify your ability to repay.
Private lenders usually require a down payment or equity of at least 15% for a borrower to be approved. However, some may ask for up to 90% of the value of the home.
What Are the Risks of Borrowing from A Private Lender?
A private mortgage can sound too good to be true, and in a way, it is. Keep in mind that there are some risks associated with a private mortgage that you need to consider.
One downside to a private mortgage is that private lenders will charge much higher interest rates than banks to compensate for the higher risk of lending money.
And if you fall behind on your payments, a private lender will move more quickly to foreclose on your home.
If you are considering a private mortgage, get in touch with an experienced mortgage broker to help you through the process. A broker will help connect you with the right lender and help you understand the terms of your private mortgage contract.
Chris Allard’s experience in the field means he can get you offers with over 50 financial institutions lending in Ottawa. Every lender has many mortgage products they offer, which means Chris and his team will make sure a mortgage caters to your needs while also ensuring you get a competitive rate. Chris Allard is a proud mortgage broker of Smart Debt Mortgages, independently owned and operated. Smart Debt broker #12236.