How Private Mortgages Work
A private mortgage is a short-term, interest-only loan used to buy property. Private mortgages are offered by independent individuals or institutions and can be easier to qualify for than loans from federally-regulated lenders.
The process of getting a private mortgage in Canada can be relatively quick and easy, but those benefits can be outweighed by higher interest rates, fees and potentially more risk.
What is a private mortgage?
A private mortgage is a loan offered by an individual or institution to prospective homebuyers who are unable to secure a home loan from a bank, credit union or alternative lender. These loans are similar to subprime mortgages.
Pros and cons of a private mortgage
Pros
- Suitable for people with poor or little credit history.
- A faster approval process.
- Open to people who don’t have traditional sources of income.
Cons
- Higher interest rates.
- Additional fees.
- Private mortgage lenders will foreclose on a home more quickly than a bank.
When is it a good idea to get a private mortgage?
Private mortgages might be a good option if:
You have poor credit history and traditional lenders won’t approve you for the mortgage you need.
You don’t have time to go through a traditional lender’s approval process.
The property you want to purchase is unconventional — in rough shape, in a remote area — and a traditional lender will not finance it.
You just need a short-term loan until you’re in a better position to secure funding from a traditional lender.
You are unable to meet the income-confirmation requirements for a traditional mortgage.
You’re a newcomer to Canada who can’t meet traditional lending standards. Foreign income, foreign credit history and a short Canadian employment history might make it difficult to be approved by traditional lenders.
You’re self-employed and have irregular income.
» MORE: How much mortgage can I afford?
How to get a private mortgage
Private mortgages are offered by individuals, syndicates and mortgage investment corporations. An experienced mortgage broker may be able to put you in touch with a reputable private lender, or you can search for one yourself.
While getting a private mortgage is generally faster and easier than qualifying for a mortgage with a bank, you’ll still have to meet some eligibility requirements. To qualify for a private mortgage, you need to have:
Proof of income: You’ll need to demonstrate that you have the income necessary to make mortgage payments. This can be tricky if you’re self-employed, and you may be required to provide extra documents.
Down payment: Usually, you’ll need a minimum down payment of 15% of the purchase price to get a private mortgage.
A sellable property: If the borrower defaults on payments, the lender will want to take possession of and even sell the property to recoup their investment.
Private mortgage terms and conditions
Private loans are often short-term, with typical amortization periods lasting six months to three years. It’s thought that, after making on-time payments over this term, the borrower will be in a better position to apply for a mortgage from a traditional lender.
The private mortgage industry is bound by fewer regulations than traditional financial institutions, so the loan conditions you encounter can vary from lender to lender.
Some might be considerably more restrictive, punitive and costly than others, so it’s important to involve a mortgage professional and a real estate lawyer when constructing a private mortgage agreement.
Private mortgage rates
Private lenders take on additional risk by loaning money to borrowers who can’t qualify for mortgages elsewhere. They offset this risk by offering significantly higher mortgage rates than those offered by traditional lenders.
The payments you’ll make on this type of loan are interest-only. With an interest-only mortgage, none of your payment goes towards the principal, so the total amount owed does not get smaller over time, as it would with a typical mortgage.
» MORE: How to pass the mortgage stress test
Alternatives to private mortgages
Get a co-signer. Friends or family members who co-sign a mortgage add the strength of their financial profile while also assuming responsibility for payments if you fall behind. Co-signers can make it possible to get approved for a traditional mortgage if your individual income and credit score don’t meet lender requirements.
Rent-to-own. These programs are structured as a long lease with an option to buy the property at the end of a specified term. You have time to save up and get into a better financial position to apply for a mortgage at the end of the lease.
Collateral mortgages. These require a second property to secure the mortgage, typically the home of a friend or family member. Having the extra collateral will make it easier for you to qualify for a loan, but both parties are now responsible for it. If either party defaults, both homes will be at risk.
Seller financing. The most popular example of seller financing is a Vendor Take Back (VTB) mortgage, in which you repay the seller directly. However, the interest rate may be higher than for a traditional mortgage.
Wait. When your finances are in better shape, you may be able to qualify for a mortgage with a traditional lender and avoid the costs and risk associated with private mortgages.
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Clay Jarvis
Clay Jarvis
Clay Jarvis