Understanding Private Mortgages in Ontario

Jul 24th 2023

This resource aims to answer your questions about private mortgages and how they stack up against conventional options. We will discuss the roles of lenders, the application process, potential advantages and downsides, and more. Stay tuned for an enlightening journey into private mortgages, beginning with an in-depth exploration in our next publication.

What is a Private Mortgage?

A private mortgage is a specific type of home loan arrangement that differentiates itself from the traditional mortgage structures offered by mainstream lenders. Unlike the latter which involves banks listed in Schedule I or II to the Bank Act (Canada), registered loan or trust corporations, licensed insurers, or their subsidiaries, or pension funds, a private mortgage is offered by an individual or entity that is not commonly engaged in lending money as part of its ordinary business.

The defining characteristic of a private mortgage lies in its exclusivity and flexibility. It is a mortgage or charge on land or property that secures a loan from a private lender in real estate transactions. As such, private mortgages can provide unique opportunities and potential advantages for certain borrowers, such as faster approval processes and more flexible terms, which we will outline in the following sections.

What Private Mortgage Lenders Offer: A Comparison with Institutional Lenders

Private mortgages differ significantly from traditional mortgages in several key aspects. Here is a comparison of what private lenders offer vis-à-vis institutional lenders:

Loan Structure and Payments: With a traditional mortgage, your payments blend both the interest and principal. As you pay off your mortgage over the term (commonly one to five years), you reduce the principal balance. However, with a private mortgage, your payments are interest-only. So, at the end of the term (usually one to three years), your principal balance remains unchanged. You’d need to renew your private mortgage or refinance to another lender, but the downside is that a private mortgage doesn’t typically lead you toward becoming mortgage-free.

Qualification Criteria: Traditional lenders mainly consider income and credit scores, which are subject to federal regulation. On the other hand, private lenders focus more on the value and type of your property to determine loan approval. They may also consider your income, down payment, and home equity if you’re refinancing your mortgage.

Interest Rates and Fees: Private mortgages are riskier by nature and thus come with higher interest rates. While a traditional mortgage interest rate is typically in the low to mid-single digits, private mortgage rates can range from 10% to 18%. Additionally, private lenders often charge a lender’s fee, typically 1-3% of the mortgage value, to the borrower amongst other fees and expenses including the lender’s solicitor fees for closing. 

Why Should I Choose a Private Mortgage?

The decision to choose a private mortgage largely depends on your personal circumstances and financial goals. While it might not be the perfect fit for everyone, private mortgages do present certain advantages that might make them an attractive option for some.

1. Flexible Qualifying Criteria: Private mortgage lenders often have more flexible lending criteria compared to traditional lenders. If you have a poor credit score, are self-employed, or perhaps a new immigrant to Canada, you may face challenges when applying for a loan from traditional financial institutions. In these situations, a private mortgage lender might be more willing to work with you.
2. Speedy Approval Process: Private mortgage lenders often offer faster approval processes. This can be particularly advantageous if you need quick access to funds, are facing an urgent purchase situation or need to capitalize on a time-sensitive real estate investment opportunity.

Remember, the key is to thoroughly assess your financial situation, understand your options, and choose the mortgage product that best fits your needs. Weigh the benefits against the potential downsides and consult with a financial advisor or mortgage broker if necessary. If you need a referral to a mortgage broker from our network, please contact us. 

Why Should I Not Choose a Private Mortgage?

While private mortgages can offer certain benefits, they also come with some drawbacks that are important to consider before making a decision.

1. High-Interest Rates: The interest rates on private mortgages are typically higher than those of traditional mortgages, often ranging from 10% to 18%. These high rates can significantly increase the cost of borrowing.
2. Additional Fees: Private mortgage lenders often charge extra fees, including brokerage fees, legal fees, and appraisal fees. These additional costs can add up and make the overall loan significantly more expensive.
3. Interest-Only Payments: With private mortgages, payments typically only cover the interest. This means that you aren’t reducing the principal amount of your loan, which can extend the repayment period and increase the total interest paid over time.
4. Lack of Federal Regulation: Unlike traditional lenders, private mortgage lenders are not federally regulated. This absence of regulatory oversight means borrowers might have less protection, making it crucial to read and understand all the terms and conditions before agreeing to a private mortgage.
5. Short Loan Terms: The loan terms for private mortgages tend to be much shorter, often only 1 to 3 years, compared to 5 years or more with a typical institutional mortgage. This shorter term can mean higher monthly payments and can increase the pressure to refinance or sell at the end of the term.
6. Risk of Foreclosure: If you’re unable to make your payments, private lenders might be quicker to foreclose on your property. This could result in you losing your home.

These potential pitfalls highlight the importance of fully understanding your financial situation and being aware of the terms of any loan agreement you consider. Always do your due diligence and consider seeking professional advice from a real estate lawyer when dealing with complex financial decisions.

Private Mortgage and Your Credit Score

Your credit score will determine your ability to obtain a loan from an institutional bank and the interest rate you would qualify for. A private mortgage may be an option for you to consider if you have less than favourable credit score ratings. In Canada, credit scores typically range from 300 to 900. The category your score falls into can influence your borrowing capabilities:

Excellent (Above 760): A credit score in this range signifies a very reliable borrower with a very low risk of default. Individuals in this bracket have the best chance of securing loans and receiving the most favourable interest rates.

Very Good (725 – 759): This range indicates a very dependable borrower. While not quite as favourable as the “excellent” category, individuals with scores in this range will still generally be offered good interest rates.

Good (660 – 724): A score in this range indicates a dependable borrower who is likely to repay debts. Individuals in this category usually won’t have issues securing loans, although they may not receive the best possible interest rates.

Fair (560 – 659): Falling in this range signifies a somewhat risky borrower. These individuals might face challenges when seeking loans and may be offered higher interest rates.

Bad (Below 560): A score in this category is considered poor and indicates a high-risk borrower. Individuals with scores in this range may face significant difficulties securing loans and, if approved, will likely face high-interest rates.

These are general guidelines and lenders may have different thresholds. It’s important to understand that credit scores are dynamic and can be improved over time. Regular credit checks, responsible credit use, and prompt repayments can help you move toward a healthier financial future. For further details on how to check your credit score, please follow this link.

Securing a Private Mortgage with Poor Credit

Navigating the complex financial landscape can be challenging, especially when dealing with adverse credit situations. However, hope is not lost. Here are some practical steps you can take to secure a private mortgage despite having a poor credit score:

• Enhance Your Credit Score: A higher credit score can increase your chances of securing a mortgage at a lower rate. If your score is less than satisfactory, take proactive steps to improve it. Pay bills punctually, maintain a credit utilization below 30%, avoid excessive credit applications, and keep your oldest credit account open. Over time, these actions can help improve your credit score, making you more appealing to lenders.
• Save a larger down payment: A larger down payment can counterbalance a lower credit score, making you less of a risk to lenders. Consider saving up to 20-25% of the home’s price for a down payment. This can lower your monthly mortgage payment, bypass the need for mortgage default insurance, and demonstrate your financial stability.
• Explore Bad Credit Mortgage Lenders: If traditional lenders decline your mortgage application due to a low credit score, consider ‘B lenders’ or ‘subprime lenders’. These lenders cater specifically to individuals with lower credit scores and may be more willing to work with you.
• Consider a Co-Signer or Joint Mortgage: A co-signer can boost your chances of mortgage approval by guaranteeing your loan. This makes the application more appealing to lenders, but remember, this is a significant financial commitment for the co-signer, and it also comes with potential risks for you.
• Focus on Your Next Renewal: A mortgage isn’t a lifetime sentence. Terms are usually for five years, during which you can work on improving your credit score. By the time your renewal comes up, you may be able to shift to an ‘A lender’, significantly lowering your interest rate. However, remember that any initial costs, like mortgage default insurance from your original agreement, will carry over.

The Bottom Line: Should You Ever Get a Private Mortgage?

The decision to secure a private mortgage is deeply personal, contingent upon your unique financial situation and objectives. While it can offer a lifeline for those with impaired credit or unconventional income sources, it’s important to remember the potential risks, such as higher interest rates and shorter loan terms, among others.

Remember, a private mortgage is a significant commitment and legal contract. It’s crucial to ensure you’re making the best decision for your situation. Get in touch with the real estate lawyers at Nazarian Law to assist borrowers or lenders in their private mortgage real estate transactions. 

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Disclaimer

The content provided in this article or blog is for informational purposes only. It is not intended to constitute legal advice or to replace the advice of a qualified legal professional. While we strive to provide accurate and current information, the law is complex and constantly changing, and each person’s circumstances are unique. Therefore, you should not rely on this information as a substitute for professional legal advice. This information does not create an attorney-client relationship between you and our law firm. We strongly recommend that you consult with a qualified attorney in your jurisdiction to understand your legal rights and obligations. Always seek legal advice before making any decisions that may impact your legal rights or obligations.