Private mortgage loans - Private Lenders

With a credit score under 600, it is likely that you will be turned down by a bad credit or prime lender and you may have to turn to a private lender. Private lenders provide an option to clients with bruised credit. Since it is a fast financing option with a higher risk to the lender, interest rates are almost always higher.

Most borrowers – real estate investors included – think of private lenders as a last-resort option if they can’t secure financing anywhere else. But private funds are gaining traction as a financing option due to the new mortgage rules set by the federal government and the continued post-crisis caution being exercised by institutional lenders. Private lenders have realized that conservative lending guidelines used by banks and conventional lenders exclude many individuals who are in fact able to pay back loans. Most importantly, private lenders take into account a property’s overall value and marketability as opposed to simply the borrower’s credit history.

The one new mortgage insurance rule real estate investors have become all too familiar with is the requirement of a 20 per cent down payment for non-owner-occupied investment property purchases. The Canadian Mortgage and Housing Corporation has also changed its underwriting policy when qualifying real estate investors for mortgage insurance, going from counting 80 per cent rental offset to an to a much lower 50 per cent addback.

Why would I use a private mortgage lender?

You would use a private mortgage under any of the following circumstances:

• You want to purchase an unconventional property that a prime lender or bank won’t finance.
• You need fast financing and don’t want to wait for a long approval process.
• Your bad credit history means you are being turned down by conventional lenders.
• You only need a short term loan.
• You have non-confirmable income that is preventing you from obtaining a traditional mortgage.

Carmen Capagnaro, an Oakville, Ont.-based mortgage broker who specializes in real estate investing, says she already sees a bigger demand for private financing due to the new rules, particularly for higher ratio, smaller investment properties like single-family homes and condo units used for rental income purposes (The CMHC can still approve commercial and multi-unit residential properties for up to 85 per cent LTV financing). “Not everyone can come up with a 20 per cent down payment, so one of the options is private money,” she says. “Anyone who is buying in that smaller category has the ability to get up to 90 per cent financing with private funds as opposed to 80 per cent with a traditional lender.”

“What we’ve seen in this marketplace is a big resurgence on the investment property side,” says Chuck McKitrick, CEO of Alta West Mortgage, a private lending company based in Calgary. “There are all these investors rolling back into the marketplace and they’re tired of dealing with the banks’ stringent parameters, meaning they’re fine with private money because it’s quick and easy even though it’s more expensive.” Something else that might drive real estate investors to private lenders are tightened CMHC rules for self-employed borrowers. These newly tweaked rules state that BFS borrowers with more than three years in the same business, as well as commissioned-income borrowers, are required to provide traditional proof of income (or “third-party validation”) to qualify for a loan. Those who have recently become self-employed and don’t have third-party validation can still apply for a mortgage, but have to come up with a 10 per cent down payment. McKitrick says these changes will have a big impact and expects to see more applications from this category of borrowers.

Types of private mortgage lenders

• Individuals - Individuals lending personal funds looking to achieve a return
• Syndicate - Group of individual investors form a funded pool which is invested on a case-by-case basis.
• Mortgage investment corp - Group of investors who pool funds available to several deals at once, as long as they meet lending guidelines

Explaining private mortgages
Private mortgage lenders operate differently from banks and other mortgage lenders on many levels. One of the major differences is their source of funding – private lenders get their money through individual investors or groups of investors. Some larger lenders have several different funding sources, or include a pool of mortgages called a MIC (mortgage investment corporation) while smaller investors might simply lend out their own money. In both cases, the private mortgage is seen as a short-term investment that can be sold off within a year or two as opposed to something to keep on a balance sheet.

Another difference between bank mortgages and private mortgages is the application process. Instead of the borrower being scrutinized, the property is what gets the most attention from a private lender. This is because private loans are uninsured, meaning the lender must fall back on the property should a default occur. For this reason, properties in smaller towns or rural areas likely won’t qualify for as much money with a private lender – 65 per cent LTV compared to 85 per cent in an urban centre, for example.

“Our primary criteria is the condition the property is in, where it’s located and how easy it is to sell if the borrower gets into trouble. If that fits, we look at the character of the client, their ability to repay, and the purpose of funds,” says McKitrick, adding Alta West doesn’t often verify borrower income, which can be attractive to many real estate investors.

Characteristics of a private mortgage

• Interest rates - 8%-18% - Private mortgage rates are the highest when compared to prime lenders and bad credit lenders and should be used as a last resort.
• Fees - 1%-3% - Private mortgage fees, including broker fees and set-up costs will amount to 1-3% of your mortgage amount
• Terms available - Terms on second mortgages can range from 1 to 35 years

Uses for private funds
While they can be used for purchases, one of the most popular borrower uses of private funds is second mortgages, which can supplement bank financing (Many banks do not grant second mortgages). This could be the case if the borrower qualifies for 75 per cent LTV on a mortgage from a bank, but needs and extra 10 per cent to purchase a property.

Real estate investors turn to private lenders for a variety of reasons. A common scenario McKitrick sees is an investor who does “fix and flips” and only needs money for a short period of time before re-selling a property.

Another instance is when the investor wants to buy a distressed property – a foreclosure, for example – and fix it up. Because banks often won’t touch these types of properties, an investor can buy with private funds and once the property is fixed and producing a cash flow, they can access cheaper funds from an institutional lender.

“For the investor, we’re often seen as that short term solution – we’re a stop-gap,” McKitrick says.

Property investors might also find themselves in a situation where their investment property is not bringing in the current market value of rent and may need time to renegotiate leases or complete renovations that will allow them to charge tenants higher rents. In this case, they could take out a second mortgage with a private lender and once the issue is solved, they could find more conventional financing elsewhere.

Another reason for using a private lender could simply be that a borrower is turned away from the bank for having too many properties in their portfolio.

“Under bank guidelines, once you’ve purchased a lot of properties to rent out, it will eventually be more difficult to qualify for further mortgages, or the banks will cut back the loan to values,” says Rajan Kaushal, president of The Money Source, a Toronto-based private lender. “That’s where second mortgage financing on investment properties comes into play because borrowers might not have enough of a down payment to purchase another property.”

The costs
Although private mortgages can help borrowers get out of sticky situations, there are additional costs to consider.

First up is the higher interest rate, which can range from a couple of percentage points above a bank loan to upwards of 20 per cent. Lenders weigh the interest rate based on the loan to value needed, the property location and the overall risk factor of the loan.

Campagnaro says most private lenders she works with charge between 12 per cent and 15 per cent for a 90 per cent LTV mortgage, but stresses many of them still only want to go up to 80 or 85 per cent. Since interest on income-producing properties is tax-deductible, it can provide relief from higher interest rates.

Other costs borrowers have to be aware of with a private mortgage are lender fees, mortgage broker fees, legal fees and an appraisal if a recent one isn’t available.

“Typically, private lenders charge a fee of two per cent of the loan, but I’ve seen in some cases if the loan is under $50,000, the lender fees go up five per cent,” says Campagnaro, adding the general rule is the higher the LTV on a private mortgage, the higher the fee.

Mortgage broker fees will generally be similar to the lender fee, and often times there are also additional charges for pulling out of a private mortgage early, although terms generally don’t exceed a year.

For legal fees, Campagnaro says borrowers have to pay for both their own lawyer and the lender’s lawyer, which can add another couple of thousand dollars to the tab. While in some cases a lender can roll these fees into the mortgage, others might not be so accommodating, so be sure to check beforehand. Also make sure to ask about the fees if you’re not sure about them – it’s a lender’s obligation to disclose all the costs associated with a mortgage before you take one out.

Where to start
While it’s possible for consumers to directly access some private lenders, most borrowers looking for these types of funds go through a mortgage broker who has connections to a wide variety of private lenders and investors.

To find a broker, try asking for recommendations from other real estate investors or check with your bank to see if they know any brokers who deal with private funds. Once you’ve found someone, McKitrick recommends asking lots of questions and making sure they have adequate experience.

“A client should interview several mortgage associates and see what kind of history they have in private lending and then, just like they would with any trade, they should do their due diligence in determining how good they are,” he says.

After you’ve nailed down a broker, they will want to know the purpose of your loan (purchase, consolidation, bridge financing, construction, etc.), the plausibility of the loan (as determined by details on the loan application) and your chances of being able to make the loan payments on time. They will structure the deal and help plan an exit strategy so the borrower won’t have to stay in a private mortgage for a long period of time. It’s also important to note that some private lenders will renew mortgages after a one- or two-year term if the payments are good and the borrower needs to stay in the mortgage for longer. The situation isn’t ideal, but Campagnaro says it can be manageable if a property is producing income and there is a cushion to pay the higher interest rate.

“At the end of the day, borrowers have to make sure their numbers work with this higher-interest mortgage – the property still has to cash flow,” she says, adding borrowers should have some extra cash in their operating accounts that could cover the asset for a couple of months should something unexpected happen.

Whatever the case, knowing the private money option is available is helpful when navigating the stricter mortgage insurance rules and added restrictions for real estate investors and self-employed borrowers. Understanding it as a short-term solution can make the extra costs easier to swallow – especially if it means acquiring a great property that might have been out of reach without the help of a non-institutional lender’s funds.

Three tricks for working with private lenders:

• Be cautious. Don’t rush when you’re signing a contract and make sure you feel comfortable with the terms. Ask questions to your broker, and if it’s a smaller private lender, don’t be afraid to ask for references. Also, make sure your lawyer reviews your contract before signing anything.
• Plan your exit strategy. With your broker, plan how to secure other financing in a relatively short period of time – private lenders don’t want to be tied to a mortgage for more than a year or two, so the idea is to use them as a “bridge” on the way to a more traditional lender with lower interest rates.
• Know the costs. The mortgage broker and lender will both charge fees for private deals (generally two to three per cent of the loan) and there are also legal fees. Remember to factor these costs in your budget and get percentages in writing. Also be sure to check what the exit fee (or prepayment penalty) is so you know what to expect if you decide to pay out the mortgage before the term expires.

What mortgage rates and fees should I expect on a private loan?

Mortgage interest rates can range from 10-18% depending on the property, borrower and current economic conditions. Since they are almost always higher than rates offered by conventional mortgage lenders, you would only turn to a private lender when turned down by banks and bad credit lenders such as HomeTrust.

Rates depend on the source of funding. If, for example, a private lender is funded by a MIC, then they will want to make a solid rate of return for their investors.

Fees associated with a private mortgage loan

With a prime or conventional lender, the broker is paid a commission directly from the lender. When using a private lender, you (the borrower) pay the broker’s fee directly. Private loans also incur set-up fees bringing total fees paid between 1-3% of the loan amount.

The good news is, these fees can be financed through the mortgage loan. Let’s say you need to borrow $100,000, and can therefore expect fees of $3,000 ($100,000 * 3%). In order to cover these fees, you would apply for a loan of $103,000 to cover the extra costs.

Private mortgage lenders specialize

Private lenders will often specialize become an expert in a certain lending category. Some examples include:

• Commercial vs. residential: Private lenders will generally specialize within a property type to focus investment.
• Re-finance for debt consolidation vs. renovation etc.: Lenders will sometimes specialize based on the reason for seeking a mortgage loan. Some lenders may only provide funds to those who are refinancing with the intention of purchasing another property.
• Prefer urban areas: Large urban centres are more appealing to private lenders as these areas carry more real estate value.
• Often prefer region they live in: Lenders are most comfortable investing in the area they live as they can personally evaluate the property. However, this is not always the case.

What time frame can I expect with a private loan?

Approval usually takes place within 1 week of application and can be as soon as a couple of days. The processing of the loan and the release of funding takes around 2-3 weeks.

Private mortgage lenders want their clients to be able to transfer on to a prime lender within a year to 18 months. They deal in fast financing and therefore need to be able to collect their return on investment within the specified time. Therefore, a private lender will try to help the client move on to a prime lender, which is also in the client’s best interest.

What criteria will they look at?

More so than prime or conventional lenders, private lenders have tighter guidelines on other factors to compensate for the added risk.

• Property type and value. This is arguably the most important factor in being approved by a private lender. The mortgaged property must be in good condition and will have to undergo a strict appraisal before you are approved. If you have a poor credit score, you are considered a riskier client and lenders need to ensure that their investment is secure, in case you default on your mortgage.
• Income. Your income can fall into one of two categories: confirmable and non-confirmable income. Confirmable income is preferred by lenders, and is proven through Notice of Assessments (NOAs).Non-confirmable income, common among self-employed or commission based employees, forces lenders to use an estimate of your income based on the average income typical of your employment.
• Down payment (if purchasing). With a private mortgage lender, the minimum loan-to-value ratio on the property is 85%. That is, you need to put in a down payment of at least 15% to be approved. If you can afford to put in a higher down payment, then it is advisable to do so. A larger down payment means you have more funds invested in the property and that you have more at stake. Lenders also take this as a sign that you can keep track of your personal finances.
• Equity (if refinancing). If you are refinancing, private lenders may allow you to go up to a maximum of 85% in loan-to-value. For example, if your property is value at $400K, you can refinance up to $340K. Many private lenders prefer a maximum LTV of 75%, especially in British Columbia. With respect to a minimum equity stake in your property, there is none.

 WHAT WILL YOU NEED WHEN APPLYING FOR A MORTGAGE WITH A PRIVATE LENDER

Mortgages through a private mortgage lender are easier to qualify for than conventional mortgage due to the fact private lenders base their lending almost solely based on your homes equity. Here is a short list of information you may need to be qualified: Mortgage Application, Credit, 1st Mortgage Statement, 2nd Mortgage Statement (if applicable) Proof of Property Taxes owed/paid if strata 1 year AGM & 1 year Strata Min and a copy of the homes fire insurance policy if in Foreclosure copy of any documents if CRA judgment a copy of documents. If you have questions please call and I can easily assess your current situation.

A Private Mortgage Lender can help with: