More Canadians have started to turn to private lenders in search of mortgage financing. With mortgage regulations continually becoming stricter and tightening the lending gap, many would-be homeowners are being squeezed out of their dreams.
Private mortgages abide by a similar set of parameters as the ones commonly imposed by many banks. However, these parameters are less rigid and allow for more creative financing scenarios. There are many financing cases that simply cannot be categorized according to a predefined set of standards that don’t allow for any compromise. These parameters are seldom updated and given the size of the large banking institutions, it makes sense how it would be difficult for them to pivot to adapt to changing consumer demands. Smaller and more nimble financiers are able to make exceptions and adapt a product box around a consumer’s needs as opposed to trying to jam a consumer within a box.
Canadians are seeking out private lenders for not only mortgage financing but also refinancing.
They may be looking to take advantage of an increase in home equity in order to develop an addition to their detached house. This is another scenario that may fall outside the lending guidelines of many traditional lenders.
Common private lending scenarios
A traditional bank requires extensive documentation supporting your ability to repay the loan. Their criteria will rule out many borrowers. For instance, self-employed applicants will not always have W2 forms and consistent pay stubs that a lender typically requires, and as such are subject to automatic disqualification.
Some common private lending cases include:
- Rental investment properties
- Multifamily (i.e. four-plex) properties
- Second mortgages
- Self-employed borrowers
- Unverifiable employment income
- Low credit score
- Higher debt load than acceptable by banks
- Construction financing
- Vacation homes
- Interim financing
Here’s a typical scenario that private lenders see. A mortgage prospect is nearly complete with the construction of a new home, and they’ve gone over their projected budget. Their bank, which has already extended a mortgage, has turned down their request for additional funds. How are they to fund the remainder of their home construction? One option is for them to consider a private lender.
Private lending restrictions and requirements
Many private lenders specialize in a particular market niche in which they are comfortable lending. A lender may only dabble in construction financing as they have expertise in home construction and may feel more comfortable in this lending scenario compared to a lender that only wishes to lend second mortgages on residential homes.
Lenders may also impose geographic constraints within their lending criteria. They may restrict their lending policy only to avoid smaller townships. There is no one defining a global lending policy that is agreed upon by private lenders or by which they are regulated. They set their own conditions and policies, and it is advisable for borrowers to seek a private lender that fits their particular circumstance not only to get more favourable rates and terms but also to take advantage of a quicker loan fulfillment process.
In terms of qualification criteria, private lenders are considerably more flexible compared to banks. Private loan applicants will find less documentation and restrictive measures heavily focused on the applicant. Employment documentation and credit history are not as critical as long as you can prove that you have the financial resources to make the necessary loan payments. The primary concern of the lender is the equity in the asset against which you are seeking a loan. Meaning, if you have $40,000 in equity on a $100,000 home, and the lender is comfortable leveraging your home up to 75%, then you would be eligible for a second mortgage of $15,000 in this scenario.
Another typical requirement from private lenders is an exit strategy indicating how you intend to repay the loan at the completion of your loan term. Essentially, a borrower needs to convince the lender of how they will repay the loan and what the source of those funds will be.
Some common exit strategy examples include:
- Renovate and resell (fix and flip)
- Develop a home on a vacant plot of land and refinance
- Credit score is low, but the borrower is going through a debt consolidation process to improve credit score
- Have another property listed for sale and require interim financing until that sale
- Awaiting inheritance or a legal settlement
Private lender fees
Because private lenders are taking on higher risks, they also charge higher interest rates when compared to the banks.
The interest rates vary among private lenders and can range from a few percentage points above a bank’s rates to double-digit rates. The rate depends on a multitude of variables that contribute to the level of risk associated with the loan. These variables typically include the equity percentage in the property, mortgage position (i.e. first, second), property type as well as what degree of documentation is provided. The lower the equity percentage in the property, the higher the risk exposure undertaken by the lender, and hence, the interest rate charged to hedge against that risk is also higher. This equity is the lender’s primary form of security in case of loan default.
When coordinating a mortgage loan process via a mortgage broker that secures a loan from a traditional lender, the broker’s fees are paid by the bank directly. In the case of a private mortgage, the borrower is responsible for covering these fees directly. The fees in question typically range between 1-3% of the loan amount. Many lenders allow for these fees to be financed as part of the mortgage loan. They are simply tacked onto the mortgage loan.
Working with a private lender
As most private mortgage loans are short-term loans ranging between one to two years, it is in the best interest of the private lender to try and help the borrower transition to a prime lender following the end of the private loan term. If the borrower has a low credit score, a lender with a qualified team of mortgage brokers will help monitor the credit score and ensure it is rising. This assistance can come in the form of debt consolidation to simply monitoring and developing a plan for the client to ensure that they are impacting their credit score by paying down their debts. Working with a private lender that also houses a mortgage brokerage team dealing with prime lenders helps clients with the transition process and also incentivizes the firm to align the client’s success with their own.
With rising interest rates and ongoing new mortgage regulations squeezing many Canadians out of homeownership, more Canadians are turning away from traditional bank lenders to alternative financing solutions. Whether they are self-employed, have unverifiable income, or unestablished credit, alternative options are becoming more prominent and mainstream. It is advisable to seek out a private lender with a diversified team that not only specializes in private lending but can also allow you to leverage their team of mortgage brokers to bridge the gap between private and traditional lending.