Consider the risks of private mortgages

Private lending is becoming increasingly popular among Canadians looking to secure loans to buy or renovate a home. 

With new mortgage stress test rules, it’s becoming more difficult for some to get mortgages from traditional lenders, particularly the self-employed, first-time home buyers and those who are credit challenged.  Homeowners seeking construction or renovation loans may also face the same challenge.

As a result, the Bank of Canada has found that more buyers are turning to private lenders. These private lenders can be investment corporations that pool capital from investors (syndicated mortgages) or individuals lending their own money. These lenders have seen their share of the market double since 2015 (Bank of Canada). 

A private lender is a person or business that loans money to someone but is not connected to a financial institution such as a bank, credit union or finance company.  Private lenders can be a relative, a friend or colleague, or someone you don’t even know. 

Mortgage loans from private lenders work just like loans from banks or credit unions. You receive funding to buy a property or make home improvements. Then, you pay the amount you borrowed back in installments, with interest. Typically, private lenders are looking to invest their money and make a return on that investment through the interest that the borrower pays on the loan. With private lenders, you may end up paying a higher interest rate than you would with a bank or credit union. 

When deciding whether to loan money, private lenders often aren’t as concerned about your credit score.  They will consider the value of the security (for example, how much your home is worth).  If you are unable to make your payments, the lender may take your property and sell it to pay off your debt.  A private lender may take legal action faster than a traditional lender.

For those unable to secure a traditional mortgage from a bank or credit union, these private mortgages could seem like an attractive alternative. 

Before entering into a private mortgage, however, borrowers need to consider some of the risks:

• Property-focused approval – In traditional mortgages, the borrower qualifies first based on their ability to repay the mortgage; then the value of the property. In private mortgages, often the property qualifies first based on its value and location; the client’s financial situation is secondary.
• Higher rates – Because private lenders are taking on higher risks, they often charge higher mortgage rates.
• Additional costs – Lender fees and/or broker commissions can add up to thousands of dollars on top of administrative and legal fees. 
• Foreclosure – Private lenders can be quicker than banks to foreclose on your home if you fall behind on your mortgage payments.
• Short-term loans – Most private lenders typically only offer a loan for a year or possibly two. Borrowers unable to obtain bank financing at renewal may end up in a cycle of these short-term, higher cost mortgages. 
• Interest-only loans – Some private lenders offer interest-only loans. Unlike standard loans, the monthly payments are applied only to the interest – and not the loan’s balance. At the end of the loan’s term, the borrower can find themselves no further ahead with the full balance still outstanding.

If you are thinking of working with a private lender, do your homework.  

• Find out the cost of any finders’ fees or brokers’ fees, the interest rate to be charged, your pre-payment options and the length of the term.
• Consult a real-estate lawyer before signing a contract.  
• If you are working with a mortgage broker, make sure another licensed brokerage is representing the private investor. 
• A mortgage broker must declare any conflicts of interest. 
• Make sure the mortgage associate or broker is licensed by the Commission. You can search our online databases here. If they are involved beyond the initial set up of the mortgage and are managing the transactions, they must also be licensed as a “mortgage administrator.”

If you are considering becoming a private lender, you need to consider these risks:

• Verify the true value of the home or property. Do your own due diligence, including obtaining an independent appraisal, checking the property registry, etc. 
• Find out if there are other mortgages registered against the property – this may impact your priority and ability to recover funds if the borrower defaults. 
• Be wary of investing in a house flip requiring renovations since the property’s value might be inflated based on proposed renovations.
• Make sure you have a contractual promise that renovations will be done.
• Make sure your mortgage broker and real estate agent is licensed with the Commission.
• Be wary of taking out a second mortgage on your own home to invest in a private mortgage.
• Consult a lawyer and obtain your own independent legal advice.
• Consult an accountant to understand the tax implications.
• If you are lending often enough to be considered in the business of providing credit, you may need to be registered under New Brunswick’s Cost of Credit Disclosure and Payday Loans Act. 

For most New Brunswickers, your home is your largest investment. Finding the right mortgage is important. Consider all the risks before entering into a private mortgage. While private lenders are not regulated, mortgage brokers representing private lenders and borrowers in New Brunswick are licensed by the Commission. Learn more about buying and selling real estate in New Brunswick on our website.