August 23rd 2021
Risks and Rewards of Private Mortgage Lenders
By Lucas Samuels
If you are considering buying a home or refinancing a mortgage, you probably have many questions about the mortgage process. What is a private mortgage lender? How can I find a mortgage specialist? What is the best mortgage to fit my needs and budget?
Another common question people have when they are about to buy their first home is, "Can I buy a house with a bad credit score?" As a matter of fact, this is a common question for people who are about to buy their first home. While this is a valid concern, it is also a question that can be answered with a yes, but the key is whether or not the borrower is prepared to take on a financial burden.
Private mortgage lenders are the mid-to-low-tier mortgage companies with the least amount of leverage and a lot less regulation than the big banks. Lenders that offer these services are often the ones that give higher rates and with looser underwriting requirements, so it's worth being cautious when choosing one.
Borrowers typically choose the private lender route when they are not eligible for a loan at a traditional bank. Private mortgages are often short-term (6 months to 3 years) with higher interest rates. For some, the guidelines at traditional banks are too stringent for their financial situation, which is why they might turn to a private lender.
When A Borrower Decides to Go For a Private Mortgage
A borrower may attempt to get approval from their bank first, but be turned away for bad credit, high debt, low income, or other issues. In this case, they would contact an alternative lender (B lender). A B lender charges higher rates than a bank, but their fixed rates are still lower than obtaining a mortgage from a private lender. B lenders include trust companies and some credit unions. In cases where a borrower is declined by a B lender for having a significant problem with their credit history, then the borrower might decide to turn to a private mortgage lender.
For private mortgages, a one year term is the most common. It’s possible to receive longer term mortgages depending on the lenders and what they offer. Typically, terms start at six months and can be as long for 3 years for first, second or even third mortgages.
Are Private Lenders Licensed in Ontario?
Private lenders do not need to be licensed. For example, individuals or corporations can lend their funds for mortgages in Canada without a license.
Types of Private Mortgage Lenders
The three most common types of private lenders are as follows:
- Individual lenders: An individual lender is someone who lends their own personal funds as a loan
- Syndicate investors: This is when a group of investors fronts their personal funds into a single mortgage.
- Mortgage investment corporation (MIC): A MIC is where a group of investors pool together their funds for investing in several different mortgages so long as the borrowers meet their specific criteria in order to qualify for the loan.
Payment Options for a Private Mortgage
For private mortgages, borrowers only have to pay interest payments on the loan. On a standard mortgage, monthly payments are blended with principal and interest, so the buyer is paying back a portion of the mortgage amount borrowed every month. The private mortgage route keeps the monthly payments more affordable and lower by only paying interest.
In certain cases, it is possible to have zero monthly payments by paying all of the interest upfront when the loan is originally funded. Further, it might also be possible to defer all monthly interest payments until the end of the term (an accrued interest private mortgage).
Lastly, a more uncommon option is to have an amortized blended payment plan which combines both interest and principal into a monthly payment in order to build additional equity in the home. With a blended amortized private mortgage it’s possible to extend the amortization term to as long as 40 years for lower monthly payments.
Private Mortgage Rates
Private mortgage interest rates are higher than traditional mortgage rates from institutions. The rates for private mortgages depend on the total loan amount, the property’s value, the property’s location, and additional factors. Private mortgage rates can start at 3.99% and go up to 13%. For second mortgages, the interest rate range is higher. Usually individual private investors can offer better interest rates than a MIC as more investors are involved and they have to charge more interest to pay themselves.
Since private mortgages can offer significantly higher interest rates than conventional mortgage lenders, borrowers opt for private mortgage lenders when they are turned down by lenders with better rates.
Private Mortgage Fees
In a conventional mortgage, a broker is paid commission directly from the lender. However, with a private lender, the borrower pays the broker’s fees directly. These fees can be paid back over the course of the loan, and range from 1-3% of the mortgage amount. For example, if you are borrowing $400,000, you can expect to pay $12,000 in fees over the mortgage term.
Focus Areas of Private Lenders
A private lender will generally have specializations in terms of what they prefer to invest in. Some examples include the following:
- Commercial or residential. To focus investment, private lenders will typically focus on one over the other.
- Refinance for debt consolidation vs renovation: Some lenders only fund loans for specific reasons. For example, they might only provide funds to borrowers looking to refinance with the intention of purchasing another home.
- Urban areas: Some lenders might prefer urban centres as these areas hold more real estate value.
- Local region: Lenders might be more comfortable investing nearby as they likely have a better understanding of the area’s real estate market and the property.
When to Opt For a Private Mortgage
A private mortgage is a good option for those who do not qualify for a B lender mortgage but are in need of a quick, short term solution. They might require more time to build up their credit, grow their income or net worth, or save for a larger down payment. In these cases, a private mortgage lender can work as a temporary solution until one’s financial situation improves.