A private mortgage can be a great way for a property owner to obtain quick equity from their property or a person who wants to escape the rent cycle and has a sizable down payment saved away to do so and has the means to make monthly payments. In both scenario, the individual may lack the credit and/or income history to qualify with a traditional lender. Private parties benefit from the interest income that they receive, while the borrower benefits by securing a mortgage otherwise not available. This article details what borrowers should know before entering into this sort of agreement.
A private lender can take any number of different forms. One of these is an institution that focuses on private lending as an investment strategy. Another is an individual investor looking for the high but still relatively stable return that private lending brings. Another possibility is a family member who has the money to invest. The benefit for the borrower with using a family member is an interest rate that may be lower than an institutional private lender. However, the risk is that if the borrower has a hard time meeting the terms, the relationship can be jeopardized. It is wise to secure the loan formally in this instance, so the lender has recourse if default happens.
Short term – a private loan is not designed to last for the entire traditional mortgage amortization period, which is often 15 to 25 or even 30 years. Instead, the loans are intended to last no more than one to two years, with three years being an exception. The borrower is not expected to pay off the whole loan over this time but instead to work to secure alternate financing, such as credit repair to make the application more acceptable to traditional lenders. Some borrowers are investors simply in need of an equity-based loan with red tape to secure interim financing until new financing is available, or a for a renovation flip.
No guarantee of renewal – There are key differences between a traditional lender and a private lender. With a traditional lender; so long as you keep your payments punctual, you are almost guaranteed renewal at the end of each term, although the interest rates may change. With a private loan, this is not a guarantee, but so long as you keep your payments on time and avoid NSF charges – and let the lender know that you will be applying for renewal – your likelihood of renewal is much greater.
Danger of market fluctuation – Private lenders do look at your credit, but they are more interested in whether the property holds enough value to pay off the loan through sale if you default, and if common sense illustrates an ability to make the payments. So, if the housing market plummets during your loan, you may require additional cash injection to secure a renewal.
Importance of credit repair – If poor credit is the reason for you working with a private lender, then we recommend that you work with a credit repair agency so that your credit improves sufficiently to gain qualification with a traditional lender.
Importance of income – Some clients need a private loan because they have not established enough of an income history, or because their income is not quite where it needs to be to satisfy debt-to-income ratios for traditional lenders. When this is the case, borrowers need to prepare themselves for the fact that approval may not come at the end of the private loan term, if they haven’t elevated their income during the private loan term.
At the end of the term, if the private lender is not willing to renew the loan and the borrower cannot qualify with a traditional lender, the borrower has the choice of finding another private lender or listing the property for sale. If the borrower does not choose any of those options, the existing private lender has the right to pursue power of sale/foreclosure at the end of the term.
There are regulations in Canada about how private mortgages can work, according to the terms of the Mortgage Brokerages, Lenders and Administrators Act, S.O, 2006, and the regulations that come with it. This gives oversight to brokers who had offered and managed mortgages for third parties. In some provinces, Private lenders must either secure a license that renewable every two years, unless they receive an exemption… OR must work through a licensed brokerage firm. This is to ensure that borrowers are working with legitimate private sources, because there are many “scams” out there where criminals posing as private lenders take up front fees from unsuspecting borrowers only to disappear once payment is received. It is important for both the lender and the borrower to have independent legal review of the terms of the contract to ensure that both sides are protected.