A “private mortgage” involves an entity or individual extending a loan for a mortgage, rather than a bank or credit union. There are many people who have the means to pay a mortgage but who do not fit within the banks’ metrics for financing approval; for them, private mortgages allow them to start working toward home ownership. As with any major financial decision, there are benefits and drawbacks with respect to private mortgages, so it’s important to make yourself aware of both sides of the decision before jumping in.
Benefits of a Private Mortgage
If you go to a bank and apply for a mortgage, the loan officer will ask you for a considerable amount of documentation. Bank statements, pay stubs, employment histories and income verification are all a part of this process. Many banks also ask about where you got the funds for your down payment. After this, they have to run a “stress test” to make sure that you can pay the mortgage each month, not just at the current interest rate but at a higher interest rate, just in case rates go up at renewal – because, in Canada, you cannot take out a loan with a term of more than 10 years, even though most mortgages are amortized on the basis of 15, 20 or 30 years.
However, even if you make plenty of money to pay the mortgage each month and have enough for a 20 percent down payment, if you are self-employed, loan officers will often scrutinize your employment and income, and if you have any credit glitches in the past seven years, that can make qualifying more of a problem.
The preferred source for a private loan could be a family member. Instead of paying a bank, you pay back your relative each month, at an interest rate that makes him or her more money than a Bank Term Deposit but less money than you would have to pay a private lender or a business offering private mortgages. Another source could be an individual or business that specializes in private lending. The interest rate will be higher than what you would pay a bank or credit union, and you will likely have to make a larger down payment (as high as 40-50% percent in some cases), but if you do that and have a relatively short term (1-2 years), you have time to get your credit score and other metrics cleaned up so that a bank refinance and payout the mortgage on or before the maturity date.
Potential Drawbacks of a Private Mortgage
Life happens sometimes, and finances suddenly become a lot tighter than they once were. For most people, the mortgage payment they make each month is the biggest bill in their budget. If your private lender is a relative, when financial stresses come, you might feel that it is acceptable for you to miss a payment or two, thinking that you will “catch up” later. This will damage the relationship between you and your family member; an investment of this size likely involves money that your relative is planning to use elsewhere – perhaps part of what he or she is counting on for retirement. So resist that temptation on months when the money is short, and cut corners elsewhere. You do not want to put your family member in a spot where he or she has to consider filing for foreclosure
This also means that you should have a frank discussion about your family member’s own finances before taking out the loan. Is the principal something that your family member can afford to lend? Could it jeopardize his or her chances of retiring at a specific point in time? Who else depends on your relative financially? Make sure that it is a sensible idea on both sides of the transaction before you take out the loan.
Make sure that you handle all of the paperwork professionally, even if you are borrowing from a family member. That means putting a lien on the house in your relative’s name and keeping it there as long as there is still money due on the loan. That way, if you take out a second mortgage, when the house sells, your family member will get paid first. Also, make sure to run a title search to ensure that the home you are buying has a clear title. This is part of the due diligence that banks and credit unions use; it protects their investment as well as yours.
Professional paperwork includes putting together a complete loan agreement, so that both you and your lender understand the terms of the deal. Do not go on the basis of a verbal agreement, because one or both of you could forget the terms over time, which could lead to an argument. Written documentation protects both of you, and it should include the payment due date (including a grace period, if applicable), the payment method (electronic, check, cashier’s check, etc.), any prepayment penalty (if applicable), the collateral securing the loan (typically the house) and any fees or recourse for the lender if you miss a payment, including reporting to credit agencies or potential foreclosure.
A secured loan will put the property as collateral. You and the lender may be tempted to omit this step because of your relationship, but if the borrower suddenly passes away or is the defendant in a civil suit, if the house is in his or her name without a lien, then creditors can go after the home – leaving the lender with nothing. A secured loan puts the lien in place and protects the lender.
So if you are thinking about a private mortgage from a relative, treat it like a mortgage from a bank or credit union. That includes completing all of the paperwork and treating the debt just like you would a bill from a bank. Many home buyers borrow money from a relative and pay off the mortgage, so they become homeowners and their relatives make some money on the interest – a win-win. With the right preparation, your private loan can work just as well.
If the thought of borrowing from family doesn’t sit well, Contact Us. We work with and underwrite for a large network of private investors partners that lend in numerous provinces across Canada. We also have strong relationships outside of our Direct Lending Group with Mortgage Companies that can only assist. Much like borrowing from Family, we can create a winning short term formula for all parties.