The Lowdown on Private Mortgages

Some prospective homebuyers are turning to private mortgages in this red-hot Canadian real estate market. A private mortgage is a home mortgage from a private individual or company that is not a federally regulated financial institution. In an environment of historically low-interest rates and strengthening demand for limited residential properties, Canada’s private mortgage lending market is thriving amid tighter federal rules and regulations. Private lenders will argue that the current rules are too conservative and could leave too many people on the sidelines, especially when prices are growing at exponential levels.

Statistics Canada data show that non-bank residential mortgages rose to approximately $339 billion as of the first quarter of 2021. The statistics agency also highlighted that non-bank lenders are deferring fewer mortgage loans, while non-bank mortgages in arrears for over 90 days have come down significantly on a year-over-year basis.

But while the industry is doing well in this type of housing sector, many homebuyers are still on the fence trying to determine if it is safe to engage in private mortgage lending.

Is Private Mortgage Lending Safe?

In recent years, private mortgage lending has gained popularity in Canada, with non-bank lenders tapping into a market that wants to achieve home ownership but cannot qualify for a traditional mortgage. But there’s a debate whether it is a safe alternative to what the big banks might offer.

The primary difference between a conventional mortgage and a private alternative is that the former requires paying the principal at a specific rate. Your monthly payments will be a combination of the loan amount and interest. Typically, private mortgages are interest-only, maintaining terms of one to three years.

Financial experts say that private mortgages are generally riskier credit products because the interest rate will be higher (generally from 10 to 20 per cent), minimizing home equity gains.

They will also utilize different qualification criteria to approve or reject applications. While traditional bank lenders will home in on income levels, credit scores, and minimum requirements established by the federal government, private mortgage lenders will concentrate on property value.

The makeup of borrowers are usually individuals making an unusual property acquisition, possessing poor credit, and having an unverifiable income.

“Unless the circumstances preventing you from qualifying for a mortgage are temporary (for example, bad credit or unverifiable income), we don’t think that getting a private mortgage is a good idea,” writes Ratehub.ca. “The high-interest rates and fees make servicing a private mortgage expensive. Most importantly, you won’t be paying down the loan principal, meaning you won’t build equity in your home or improve your financial situation.”

Pros and Cons of Private Mortgage Lending

Pros

#1 Easier to Qualify

When you do not have the income, paperwork, and tax documents, you will usually not qualify for a mortgage from a financial institution, whether for $100,000 or $1 million. This is especially true for small business owners, independent contractors, and other self-employed professionals. A private mortgage lender will be much more lenient since the organization will be focusing on the property value. Of course, you need some income stream to be approved for a mortgage.

#2 Faster Approval Process

The mortgage application process at any of the big banks and credit unions can be a strenuous and lengthy affair. By the time your application is approved, prices will likely rise, or the property you have been targeting is gone. The private mortgage application process is much faster, meaning you can dip your toe in the Canadian housing market quicker.

#3 No Stress Test Necessary

Last summer, Ottawa raised the mortgage stress test  to 5.25 per cent for its five-year benchmark rate. This determines if you can afford your mortgage at a higher rate. Since a private mortgage is uninsured, it is not mandated to abide by the stress test. This can allow more households an opportunity to achieve home ownership.

Cons

#1 Higher Interest Rate

These days, a bank mortgage will usually be around two percent. A private mortgage will be in the double digits, making your monthly payments tremendously high, especially when you are receiving a vast amount. Considering that the average price for a home in Canada is about $820,000, the interest you would pay would be immense.

#2 Additional Fees

Mortgage lending is notorious for the number of fees and taxes you have to pay. It is no different with private mortgages, except they might be even more extensive. For example, you will pay broker fees and set-up costs representing up to three percent of your total mortgage amount.

#3 Could Be Bad for Your Finances

You may be denied a traditional mortgage because you do not have the means to carry a mortgage. Or, at the very least, this is what the bank thinks. You cannot afford mortgage payments, interest charges, and the myriad of other fees and taxes you will inevitably bear. While a private mortgage skirts these hurdles, they are still red flags about the dangers of getting a mortgage, particularly at a time when home prices are surging nationwide.

Moreover, even if you have the income to carry a mortgage, you will still owe the principal amount, and your home equity will be eaten away by the interest.

Sources:

• Statistics Canada
• Ratehub
• CREA