As interest rates have increased over the past year along with the cost of living and other expenses, more and more borrowers are unable to qualify for bank or institutional mortgages when buying a property or when renewing the mortgage at maturity. As a result, many borrowers are resorting to private mortgages to allow them to close their transactions. This column will examine private mortgages and offer some guidance for individuals who are considering a private mortgage.
A private mortgage is an agreement between a borrower and a private individual lender in which the lender provides financing to the borrower. They are often used when the borrower cannot obtain traditional financing from a bank due to a low credit score or because they don’t meet traditional lending requirements. Self-employed borrowers may not qualify for institutional mortgages and may need to arrange a private mortgage. Unlike traditional mortgages from a bank, private mortgages are not regulated so it is therefore important that you work with a reputable lender. The best way to do this is to work with a knowledgeable and well-connected mortgage broker who can find and arrange a private loan. Here are some other things to watch out for with private mortgages:
- The interest rate on private mortgages will be higher than traditional mortgages. This is because these mortgages are considered higher risk for lenders. The rate and terms are negotiated between the lender and borrower usually with the assistance of a mortgage broker.
- There are also additional fees associated with private mortgages such as appraisal, lender, broker and legal fees. The borrower is typically responsible for paying all of these fees which can be substantial. In some cases, the fees can be rolled into the mortgage. The borrower should ask about these fees before agreeing to the mortgage terms.
- The mortgage may contain stringent terms and conditions in favour of the lender and not always in the best interest of the borrower. For instance, the mortgage may contain provisions to prohibit the owner from obtaining another mortgage against the property, renting the property or doing construction on the property. As well, like with institutional mortgages, selling or transferring the property without the lender’s consent or failure to pay the property taxes or common expenses or maintain insurance on the property may constitute default under the mortgage.
- With private mortgages, when the borrower defaults on the mortgage, the private lender may charge substantial fees to bring the mortgage back into good standing. Also, when there is a default, a private lender will act much quicker than an institutional lender in commencing legal or power of sale proceedings. Institutional lenders will often try to work with the borrower to remedy the default before resorting to legal action to enforce the mortgage.
- If the mortgage requires monthly payments, failure of the borrower to make a payment on the required due date will often attract NSF fees which the borrower will have to pay.
- If the borrower desires to renew the mortgage upon maturity, they may not have the automatic right to do so and may require the consent of the lender. Without this, the borrower may be forced to sell the home. The private lender, knowing that the borrower has limited options, could charge exorbitant renewal fees and penalties in order to renew the mortgage.
- In the event the borrower fails to make a payment on the mortgage or defaults, the lender may take action to enforce the mortgage by power of sale. If this happens, there can be daily maintenance fees as well as legal fees and other costs involved which are often substantial.
- If arranging a private mortgage, it is important for the borrower to plan ahead and have a well-defined exit strategy. Many private mortgages are temporary or stop gap solutions where the borrower needs short term financing and then plans to obtain financing from a bank once they establish or improve their income and credit score. Without a clear exit strategy, borrowers may find themselves in a challenging position facing higher interest rates with limited refinancing options or the need to sell in an unfavourable market.
Lately, I have come across many situations where a pre-construction condominium was purchased years ago, and the final closing is coming up. The borrower is now faced with much higher interest rates and cannot qualify for a bank mortgage and is now faced with the prospect of not being able to close the transaction and possibly forfeiting its deposit and being sued for breach of contract. To avoid this, the borrower may have no option but to arrange a private mortgage.
If arranging a private mortgage, it is imperative to consult with an experienced mortgage broker and real estate lawyer to understand the terms and risks.
This article was written with the input of Steve Kornbluth with TMG SafeBridge Mortgage Solutions.