All you need to know about Private Mortgage Lending
If you’re in need of a mortgage or a smaller home equity loan, private lending is just one of many options. Though loans from private lenders aren’t suited to everyone, they can be useful if you have poor credit, if you’re refinancing a mortgage or taking out a second mortgage, or if you need a small home equity loan faster than banks can provide it.
Private mortgage lending is very similar to conventional mortgage lending by banks and other federally regulated financial institutions, though it does come with some key differences. It’s important to understand the advantages and disadvantages of a private loan before applying.
Mortgage loans from private lenders
If your first question is “where can I get a private loan?” the answer is, any private or alternative lender. The question, then, is how to find private lenders. Luckily, with strong demand for mortgage and home equity loans, especially in large cities like Toronto, with strong real estate markets, there are numerous options for any borrower.
One good approach is to look for experienced private mortgage brokers. A broker is different from a mortgage lender in that a broker acts as a “middleman” between the lender and the borrower. A broker can quickly put you in contact with a lender that can offer a loan to suit your budget, your property type, and your desired mortgage structure. Approaching a broker can save you from the time-consuming task of researching and speaking with many different lenders.
Why choose a private mortgage?
When people think of mortgages, they tend to think of traditional mortgage loans -- long term bank loans that cover a majority portion of a property’s selling price and are paid off over decades in monthly installments. Certainly, these types of loans are common, and bank mortgages are usually advantageous in that they can be for higher sums, and they tend to carry lower interest rates than private mortgages.
The downside to bank mortgages is that they also come with a lot of restrictions. These restrictions are enforced by the federal government, and part of their purpose is to help protect potentially vulnerable borrowers from taking out loans that they ultimately can not afford. However, because these restrictions are designed to cast as wide a net as possible, there are cases where a borrower who could afford a mortgage can’t be approved due to technicalities. For example, if you’re self-employed or own a small business, your income may be difficult to prove on paper. If you’re young and haven’t taken out any previous loans or made any previous investments, the bank might not have enough information to adequately determine whether or not you’re financially reliable.
In these cases, a private first mortgage might be a suitable alternative. Private lenders aren’t required to follow those same federal regulations, so they tend to focus mostly on the value of the property that’s being borrowed against. As long as you have at least 20 percent equity available in your home, you can be approved for a mortgage from a private lender.
Equity is defined as property value that doesn’t have a loan secured against it. For example, if you buy a home worth $1,000,000 and get a mortgage for $800,000, then 80 percent of your home has debt against it, and the remaining 20 percent is available equity. As you pay down your mortgage, your equity increases -- if you pay off another $200,000, making your outstanding debt $600,000, you now have 60 percent debt and 40 percent equity.
If you don’t have an existing mortgage on your home, be prepared to put down at least 20 percent of its value as a down payment up-front.
Private mortgage lender rates
With any kind of loan, interest is designed as a kind of safety net to protect the lender’s mortgage investment from loss. Mortgage interest rates can vary significantly depending on the type of lender, the property type, the structure of the loan, and the borrower’s credit history.
If you have a superb credit score and you’re taking out a prime mortgage from an A lender like a bank, your interest rate might be as low as 2 percent. On the other end of the scale, if you have poor credit and are taking out a second mortgage from a private lender, your interest rate will be much higher -- think 12 to 18 percent.
Private mortgage lenders in Ontario can offer second mortgages and bad credit mortgages as well as more traditional mortgage structures, so the rates for private mortgages can be anywhere from 5 to 18 percent, depending on the above factors.
Private Mortgage Lenders versus Banks
To be approved for a mortgage from a bank, you’ll need a credit rating of at least 680. You’ll also be required to provide paperwork proving your financial history and current income. Documents that you’ll likely need to provide include, but are not limited to:
- Recent tax returns
- Government identification
- T4s or other proof of income
- Investment certificates
- Bank statements for existing accounts or credit cards
- Records of employment
The pre-approval and approval process for a bank mortgage can be time consuming.
Because private mortgage lenders are more concerned with the value of the property and your current income situation, the approval process is often somewhat faster. While you will still need to provide some documentation to show that you have stable income and can be reasonably expected to meet monthly payments, you won’t necessarily need to go through a stress test (unless your lender specifically requests it).
Private mortgage lenders also tend to be somewhat more flexible in terms of the types of loans they can offer. If you need a short-term loan, or a smaller home equity loan to cover a temporary expense, a private lender will likely be able to provide you with funds faster than a bank.
Private lenders for mortgages with bad credit
Given all of the above, when should you get a private mortgage? When is it more advantageous to approach a private lender than to go through major banks?
One very common reason for borrowers to approach a private lender is bad credit. If you have a credit score below 680, it’s unlikely that you’ll get approved for any sort of mortgage loan from a bank. Those with scores between 550 and 600 might still be able to get a subprime mortgage from a credit union or trust, but if your credit score is below 550 (in the poor credit range), you may have to turn to private lending.
Since private lenders are primarily concerned with the current value of the property, credit scores are used as a kind of secondary metric. The better your credit score, the lower your prospective interest rates, but bad credit alone won’t stop you from being approved.