How to Use a Private Mortgage
A Loan that Benefits Everybody
A private mortgage is a loan made by an individual or a business that is not a traditional mortgage lender. Whether you’re thinking of borrowing for a home or of lending money, private loans can be beneficial for everybody if they’re done correctly. However, things can also go badly — for your relationship and your finances.
As you evaluate the decision to use (or offer) a private mortgage, keep the big picture in mind.
Typically, the goal is to create a win-win solution where everybody gains financially without taking too much risk.
Private mortgage or hard money? This page focuses on mortgage loans with somebody you know. If you’re looking to borrow from private lenders (that you don’t know personally), read about hard money loans. Hard money lenders are useful for investors and others who have a hard time getting approved by traditional lenders. They are often more expensive than other mortgages and require low LTV ratios.
A Private Mortgage Might Be Right for You
There is a stigma attached to private mortgages and it needs to end. Private funds are one of the largest growing financing segments in Canada. With Canada’s stricter mortgage rules, it is making alternative financing more popular than ever. From 2016 to 2019 the percentage of private mortgage transactions grew from 12 per cent of all mortgage lending to 20 per cent, is a 67 per cent increase.
Private money is all about equity lending, an arena where the banks used to be able to compete. Equity lending means that when a client has great credit and pays their bills, but doesn’t not have the traditional income to support the lender’s stiff guidelines, they are able to borrow against the fact that they have good equity built up in their homes.
In the past, the banks would lend up to 65 per cent of the value of the property, but they no longer make that option available. As a result, private lenders are meeting that need instead.
At the Wilson Team of Mortgage Experts, we are intimately acquainted with private lending. We have personally borrowed private funds as investors for acquisitions and we have our own funds invested in private mortgages. We can teach everything you need to know about both. We are self employed Investors that use private money all the time to grow wealth while we get to tax deduct the interest and the fees.
This is just one great way to use private funds. Many types of consumers can take advantage of private funds. They can be used for such purposes as construction, land, bridging, VTB’s, and rehab homes. It can also be just as simple as obtaining the funds to pay some outstanding income tax arrears or saving a very large mortgage penalty with a BIG bank when they may not lend you the funds.
Another way to take advantage of private funds is when you or a family member retires. You want to get the home fixed up, renovate or add a secondary dwelling before selling, but due to a new pension or a lower income, the banks won’t lend the additional funds. Private funding can be a great temporary solution, as you only have to pay the interest.
One of the major reasons we see for borrowing private funds is when someone becomes ill or passes away; the family income may not be able to be proven the same way, the credit has taken a hit due to high debt loads and the banks see it as a risk. In a case like this, we would recommend a second mortgage for the amount owing to wipe the slate clean and get the credit built back up; they can then go back to the first bank to do a refinance or do a carry over for the estate.
Many clients who are ill or have a loved one needing care find themselves in a difficult financial position for some time, due to the travel required or the need to take time off work, along with medical expenses that are not covered by insurance. As a prospective homeowner, investor or current homeowner, you may discover that private mortgages are a wonderful solution. Let us, the Wilson Team of Mortgage Experts, find you the perfect private lender.
Private Mortgages Explained
A private mortgage is mortgage funded by private investors. Generally, it is a short-term loan of one to three years that provides bridge financing to get you started on the path to equity and gives you the ability to refinance with a financial institution. The private mortgage is generally available for up to 85 per cent of your potential equity in a home. For example, if you plan to purchase a home for $100,000, a private mortgage would provide up to $85,000. In some circumstances there is the ability to go higher than the 85 per cent. Each case is analyzed based on situation, exit strategy and reason for the funds.
Private lenders come in various shapes and sizes, but they generally fall into one of three categories:
- The individual lender: A private individual who invests in mortgages as a way of earning a return on investment that the lender considers more reliable than the stock market.
- The mortgage investment company (MIC): A company that uses a pool of money from various individual investors to make mortgage loans on a case-by-case basis.
- The mortgage syndicate: A group similar to a MIC that generally funds large projects, such as a condominium development, and may fund a number of projects at once.
We at the Wilson Team of Mortgage Experts will discuss your requirements and circumstances with you and match you with a lender who can meet your needs.
Why Consider a Private Mortgage?
Conventional mortgages aren’t right for everyone. Traditional lending institutions tend to prefer cookie-cutter applicants whose circumstances fit a checklist of characteristics. You may wish to consider aprivate mortgage if, for example:
- You are self-employed or work on commission, meaning that your income fluctuates;
- You need quick turnaround on your mortgage loan and don’t want to wait for the usual lengthy approval process;
- Your income-to-debt ratio is high;
- You’ve recently filed for bankruptcy;
- You are buying an unconventional property, such as a rehab, castle, church or a farmhouse;
- You want to build on vacant land;
- You plan to purchase a pre-fabricated home;
- Your home has structural issues or water damage; or
- You don’t have a stellar credit history, making you too high a risk for traditional lenders
- You are an investor with lots of equity
- Major renovation
- And much more
What Are the Major Benefits?
Private lenders aren’t obsessed with every detail of your financial life and are more flexible in their thinking about what constitutes a reasonable risk. The investors are looking at sustainability, exit strategy, type of property, and equity. Its make sense lending. You can get terms from 3 months to 3 years.
You also get personalized service. We at the Wilson Team of Mortgage Experts will strive to offer you a choice of private lenders, investors and alternative options. rather than a single option, and we will ensure that they understand your situation and your needs.
Private lenders may also facilitate your move to a bank loan after a year or two, rather than leaving you to fend for yourself. Investors of this type are interested in loaning money and getting quick returns on their investment, so private mortgages are designed to be short term.
What Are the Key Criteria?
Since you are potentially a higher-risk client than the traditional buyer, based on your credit history, your income or the type of property you plan to purchase, the private lender will look seriously at a variety of factors in making a decision:
- Property Type and Value: The lender will ensure that the potential property is appraised thoroughly; it must be in good condition or you may be considered a poor risk.
- Down-Payment: Private loans require a down-payment of at least 15 per cent. It is always advisable to offer more, if you have the money available, because it gives you a larger stake in the property, something potential lenders see as a good sign.
- Income: If your income stream is regular and confirmable, it makes it easier for private lenders to feel comfortable about a mortgage loan. If your income fluctuates, you can provide tax information to reassure them; otherwise, they will base their assessment on general averages for your job type.
- Equity for Refinancing: If you’re refinancing, rather than purchasing, private lenders may provide as much as 85 per cent of the equity value of your home as a loan. However, that is not guaranteed – in certain regions, 75 per cent is more common.
The Process Once you make your mortgage application, things move quickly. Private lenders generally approve applications within a week and are able to provide you with the necessary funds within two or three weeks of approval. In applying for and obtaining a private mortgage, you must be prepared for the associated fees and costs. Private broker and set-up fees will probably cost between one and three per cent of your mortgage amount, while interest rates may range anywhere from 6 to 18 per cent. Interest rates for private mortgages are higher than bank rates, because you are deemed a riskier investment than the average loan applicant, and a private lender is putting his/her personal money on the line. He/she has no safety net in the event that you are unable to repay the loan.
If you’d like to close on that property sooner, rather than later, and banks aren’t a viable or preferred lending option, a private lender could be right for you. Give us, the Wilson Team of Mortgage Experts, a call and we’ll be happy to connect you with a lender who meets your needs.
Why Go Private?
The world is full of lenders, including big banks, local credit unions, and online lenders. So why not just fill out an application and borrow from one of them?
Qualifying: For starters, borrowers might not be able to qualify for a loan from a traditional lender. Banks require a lot of documentation, and sometimes your finances won’t look the way the bank wants. Even if you’re more than able to repay the loan, mainstream lenders are required to verify that you have the ability to repay, and they have specific criteria to complete that verification.
For example, self-employed individuals don’t always have the W2 forms and steady work history that lenders like, and young adults might not have good credit scores(yet).
Keep it in the family: A loan among family members can make good financial sense.
Borrowers can save money by paying a relatively low interest rate to family members (instead of paying bank interest rates). Just be sure to follow IRS rules if you plan to keep rates low.
Lenders with extra cash on hand can earn more by lending than they’d get from bank deposits like CDs and savings accounts.
Understand the Risks
Life is full of surprises, and any loan can go bad. Of course, everybody has good intentions, and these deals often seem like a great idea when they first come to mind. But pause long enough to consider the following issues before you get too deep into something that will be difficult to unwind.
Relationships: Existing relationships between the borrower and seller may change. Especially if things get difficult for the borrower, borrowers may feel extra stress and guilt. Lenders also face complications — they may need to decide whether to sternly enforce agreements or take a loss.
Lender risk tolerance: The idea may be to make a loan (with the expectation of getting repaid), but surprises happen. Evaluate the lender’s ability to take risk (becoming unable to retire, risk of bankruptcy, etc.) before moving forward. This is especially important if others are dependent on the lender (dependent children or spouses, for example).
Property value: Real estate is expensive. Fluctuations in value can amount to tens (or hundreds) of thousands of dollars. Lenders need to be comfortable with the property condition and location — especially with all of those eggs in one basket.
Maintenance: It takes time, money, and attention to maintain property. Even with a good inspector, issues come up. Lenders need to be sure that the resident or owner will address problems before they get out of hand and be able to pay for maintenance.
Title issues and order of payments: The lender should insist on securing the loan with a lien (see below). In case the borrower adds any additional mortgages (or somebody puts a lien on the house), you’ll want to be sure that the lender gets paid first. However, you’ll also want to check for any issues before buying the property. Traditional mortgage lenders insist on a title search, and the borrower or lender should ensure that the property has a clear title. Title insurance provides extra protection, and would be a wise purchase.
Tax complications: Tax laws are tricky, and moving large sums of money around can create problems.
Before you do anything, speak with a local tax advisor so that you’re not caught by surprise.
Private Mortgage Agreements
Any loan should be well-documented. A good loan agreement puts everything in writing so that everybody’s expectations are clear and there are fewer possible surprises. After several years, you (or the other person) may forget what you discussed and what you had in mind, but a written document has a much better memory.
Documentation does more than just keep your relationship intact — it protects both parties to a private mortgage. Again, you don’t know what you don’t know about the future, and it’s best to avoid any legal loose ends from the get-go. What’s more, a written agreement might make the deal work better from a tax perspective.
As you review your agreement, make sure every conceivable detail is spelled out, starting with:
- When are payments due? Monthly, quarterly, on the first of the month, etc.
- What if payments aren’t received? Can the lender charge a fee, and is there a grace period?
- How/where should payments be made? Electronic payments are best.
- Can the borrower prepay, and is there any penalty for doing so?
- Is the loan secured with any collateral? It better be.
What can the lender do if the borrower misses payments? Can the lender charge fees, report to credit reporting agencies, or foreclose on the home?
Secure the Loan
It’s wise to secure the lender’s interest — even if the lender and borrower are close friends or family members. A secured loan allows the lender to take the property (through foreclosure) and get their money back in a worst-case-scenario.
Is that really necessary? Again, you don’t know what you don’t know about the future.
A borrower (who has the ability and every intention to repay) may die or get sued unexpectedly. If the property is held in the borrower’s name only — without a properly filed lien — creditors can go after their home or pressure the borrower to use the home’s value to satisfy a debt. A secured mortgage helps protect the lender’s interest, assuming everything is structured correctly. In fact, the term “mortgage” technically means “security” — not “loan.”
Securing a loan with property may also help with taxes. For example, the borrower might be able to deduct interest costs on the loan, but only if the loan is properly secured. Talk with a local tax preparer or CPA for more details and ideas.
How to Do a Private Mortgage Correctly
If you’re considering a private mortgage, think like a “traditional” lender (although you can still offer better rates and a more consumer-friendly product). Imagine what could go wrong, and structure the deal so that you are not dependent on good luck, good memories, or good intentions.
For documentation (loan agreements and filing liens, for example), work with qualified experts. Talk to local attorneys, your tax preparer, and others who can help guide you through the process. If you’re working with large sums of money, this isn’t a DIY project. Several online services can handle everything for you, and local service providers can also do the job. Ask exactly which services are provided, including:
- Will you get written mortgage agreements?
- Can payments be handled by somebody else (and automated)?
- Will documents be filed with local governments (to secure the loan, for example)?
- Will payments be reported to credit bureaus (which helps borrowers build credit)?