Private Mortgage Explained: Everything You Need To Know

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Overview of Private Mortgage In Canada

A private mortgage is a short-term alternative mortgage financing solution for borrowers who cannot qualify with mainstream mortgage lenders like banks, credit unions, and other monoline mortgage lenders, probably due to their credit score or income.

You can use this loan to buy or build a house, buy land, finance your lifestyle, support your family, and more.

Just like a mortgage from your bank, a private mortgage is registered against the collateral of your house, meaning your home can be repossessed if you fail to satisfy the obligations of the mortgage agreement.

What Is A Private Mortgage?

A private mortgage is a short-term mortgage from a friend, family member, colleague or investment firm registered against the collateral of your house. Private mortgage terms range from six months to 3 years.

The main feature of private mortgages is their interest-only payment structure. Meaning you are not obligated to pay the principal of the loan. As an interest-only loan, expect your mortgage balance at the end of the mortgage term will still be the same as the balance at the start.

For example, if you borrowed $250,000 for a one-year term and paid $1,800 monthly. At the end of the term, one year from today, you will still owe $250,000, even though you have been making regular payments of $1,800.

The $1,800 is only the interest of the mortgage. Unlike an amortized loan, the interest paid does not change and affects the mortgage balance.

How Does A Private Mortgage Loan Work?

The popularity of private mortgages has witnessed tremendous growth. Not everyone can qualify for a mortgage with a mainstream lender. If you are self-employed, bankrupt, or have a low credit score and non-confirmable income.

Getting approved for a mortgage with a traditional lender will be tough. Also, finding a mainstream lender willing to finance the home purchase can be challenging if you are looking to buy a unique property.

The first step is to hire a mortgage broker specializing in alternative mortgage solutions. Unfortunately, you can only access a private mortgage through a licensed mortgage broker.

Your mortgage broker will consult with you to better understand your mortgage needs. They will also discuss an exit plan to move your mortgage to an institutional lender at the end of your mortgage term.

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Benefits Of Private Mortgages

Not everyone is eligible for a mortgage with a mainstream lender. Private mortgage lenders play an essential role in helping borrowers who cannot qualify for a traditional mortgage fulfill their homeownership dreams. Here are a few benefits of a private mortgage.

Easy To Qualify

It is easy to qualify for a private mortgage. Regulated institutions like banks, credit unions or investment trusts will require documentation. They must validate the sources of every income used to support the ratios. These lenders also screen credit scores, accepting only clients with excellent credit scores and clean histories.

These strict requirements make it difficult for some borrowers to qualify for a mortgage loan. For example, a self-employed borrower will need at least two years of business operating history, T1-General of the Business Tax Filing, Accountant Prepared Audited financial statements, business bank statements and all the incorporated business documents.

A private lender is not obligated to request all the above documents. They are lending on the property, not necessarily on your credit or income, making qualifying for a private mortgage easy.

Fast Turnaround

You can go through the entire process for a private mortgage transaction, from application to funding, in under 48 hours.

That’s impossible to do with a mainstream lender. Even if you have all your documents up front, it will take weeks to months to complete the mortgage process with a bank or credit union.

Mainstream lenders have internal bottlenecks which applications have to go through. Every step in this process delays the funding date. It is common to postpone your closing date because the lender could not complete its internal operation in time.

Flexible Repayment Terms

Private mortgage lenders have flexible payment terms. You can choose the equity in your property to prepay (pay upfront) Part or all of the interest expense.

Your mortgage loan will be increased by the added amount needed to cover the interest payments. The increase will depend on the equity you have in the property.

For example, let’s say you request $150,000 for a 1-year term with a monthly interest expense payment of $1,200.

Prepaying Part of the mortgage payment

If you prepay \$600 of every mortgage payment for the entire term, upfront.
The entire term upfront interest expense payment is $600 x 12 = $7,200
The private lender will increase your mortgage loan by $7,200
Therefore, your actual mortgage loan will be $157,200

Prepaying all of the mortgage loans

You want the entire interest expense to be prepaid. Meaning you won’t make any payment for the whole term of the loan.
The 12 months interest expense is $1,200 x 12 = $14,400
Your mortgage loan will be $164,400
The loan is increased by $14,400

Allowing you to prepay Part or all of the required interest payment upfront will help you take control of your financing. That should also make it easy to manage your other debt obligations.

Low Prepayment Charges

Most private mortgages are open-term, meaning you won’t be penalized if you choose to pay back part or all of the mortgage before the end of the term. Banks and other institutional lenders use a prepayment penalty to discourage borrowers from fast-paying their mortgage loans. The prepayment penalty amount can be pretty high.

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Drawbacks Of Private Mortgages

A private mortgage is not the go-to mortgage. Borrowers do not go for a private mortgage by choice but by circumstance for the following reasons.

Higher Interest Rate:

Interest rates for private mortgages are higher than interest rates for mainstream mortgages. The interest rate for first-position private mortgages is usually between 4% to 9%. Second position private mortgage interest rates are often in the two digits. It is not uncommon to get a rate of 14% for a second-position private mortgage.

High Borrowing Costs

In addition to the high interest, the overall cost of borrowing a private mortgage is also very high. The origination fee can go up to 15% of the loan amount.

To give you an idea of what it will cost you to borrow a $150,000 private mortgage,

Lender Fee: The lender will charge you this fee to cover the administrative costs of originating the loan. This fee is calculated as a percentage of the loan amount. It usually ranges from 2% to 6%. Thus, it will be between $3,000 to $9,000 for this $150,000 mortgage.
Broker Fee: Unlike a mortgage from a bank, mortgage brokers are not compensated by private lenders for their services. Brokerage or broker fees are around 1% to 4% of the loan amount. Thus, it will range from $1,500 to $6,000
Lawyer Fees: There are typically two lenders involved in a private mortgage transaction; the lender’s lawyer and your lawyer. You pay the fee for both lawyers and the borrower. The lawyer fee for both lawyers can be around $4,000.
Appraisal Fee: Appraisal is a must for a private mortgage. Private mortgage lenders lend on the property’s location, condition, and value. Depending on the location of the property, the appraisal cost can go up to a $900

Short Term Nature

By design, private mortgages are short-term. They are meant as transitional solutions to help you re-established your situation so that you can qualify for a low rate and better terms mortgage with an institutional lender. However, the short term might not be enough to get some borrowers ready to transition to institutional lenders. For example, bankruptcy needs more than three years to get re-established.

Interest-Only Nature

You are not paying down your mortgage loan. It is common to end with a much higher mortgage than you borrowed. This might be a difficult situation in a declining house price environment. That may leave you with a higher mortgage than the value of your house.

Also, because you are not paying down the mortgage loan, it may be challenging to refinance with a mainstream lender at the end of the term if your loan-to-value ratio is above 80%. That means the proportion of the mortgage loan to the property’s value at the end of your loan term is higher than 80%.

Mainstream lenders are required to only refinance mortgages with a loan-to-value ratio of 80% and lower.

Something you have to watch out for if you are seeking a private mortgage and planning for a mortgage refinance as your exit strategy.

Is Private Mortgage Right For You

A private mortgage is not for everyone. As explained above, people seek a private mortgage, not by choice. The below points will help you decide if a private mortgage is right for you.

You can also contact approvU for a free mortgage financing consultation to help you decide the correct route to take for your mortgage needs.

Private mortgages are often suitable if you:

Are self-employed with less than two years of operating history
Are you unable to confirm your income with the traditional documentation
Want to purchase a unique property or a raw land
Have less than ideal credit
Want to invest in real estate
Want to access the equity in your house without refinancing your mortgage
Need to consolidate high-interest-rate debt
Looking for a short-term loan

Final Thoughts On Private Mortgage

Even with the high-interest rate and borrowing costs of private mortgages, they can still be a wise option. A private mortgage might be the lever you need to spring into financial freedom.

The loan can help you consolidate your high-interest credit card debts or access the equity in your house for other personal needs. The less red tape for private mortgages makes them a quick home financing solution.

However, your house can be repossessed if you are unable to make the required payments. It is advisable to use this private mortgage as a short-term solution so that you can re-established whatever is holding you back from getting qualified with a mainstream lender.

You must have an exit strategy before going into a private mortgage. An exit strategy is what you need to get out of the private mortgage contract. It can be to refinance the mortgage or even sell the house. But you don’t want to stay in a private mortgage contract for long.

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Private Mortgage Explained: Everything You Need To Know

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In This Guide

Overview of Private Mortgage In Canada

What Is A Private Mortgage?

How Does A Private Mortgage Loan Work?

Shop Across 25+ Lenders For Your Best Mortgage Deals

Benefits Of Private Mortgages

Easy To Qualify

Fast Turnaround

Flexible Repayment Terms

Low Prepayment Charges

Shop Across 25+ Lenders For Your Best Mortgage Deals

Drawbacks Of Private Mortgages

Higher Interest Rate:

High Borrowing Costs

Short Term Nature

Interest-Only Nature

Is Private Mortgage Right For You

Final Thoughts On Private Mortgage

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