The recent changes
to mortgage eligibility requirements – and, to some extent, the changes for insured mortgages
– may have the desired effect of slowing down surging markets and protecting the long-term financial security of borrowers and all Canadians, according to finance minister Bill Morneau, but they may also have an effect on so-called shadow lending.
Owning a home isn’t a right for every person. It depends on your affordability, and whether or not you are deemed to be a fit borrower – and by whom. If you’re being pushed out of the mainstream mortgage market, then there are other options, such as private lending.
have been around for a long time. The private lending market is largely unregulated, thereby operating in the shadows of the traditional mortgage market. It’s a very small segment of the market, but it is growing; loans from non-deposit-taking institutions have doubled since 2012 and the share of the less regulated entities in the mortgage market as a whole accounts for less than 5%, according to a CIBC report
issued last year.
“The bottom line is that regardless of how you measure it, alternative/non-prime lending, while rising, is still an extremely small portion of total mortgage activity in Canada—probably smaller than perceived by many. That is not to suggest that the system is risk free . . . the risk we are facing today is that increased regulations on major financial institutions combined with even lower mortgage rates may work to widen those shadowy margins.”
This conversation isn’t anything new. Every time changes to mortgage lending are introduced, people fret about shadow lending, and how it creates an even riskier mortgage loan environment. In the alternative space, interest rates are higher, mortgage terms are shorter, and without any oversight to regulate these loans, consumers are often left to discern a quality lender from a shady one.
Part of the growth of shadow lending is fueled by investors who are willing to back these products that can get them much higher returns than they can in other, safer vehicles, given the low interest rate environment. Some people in the lending industry – and some people watching from the outside – are concerned that the growth will also be exacerbated by the flood of homeowners who are no longer eligible under the new rules.
For policy makers, if you can’t meet the new mortgage stress tests, then the clear answer is to wait to buy a home, or to not buy one at all. Unfortunately, people may not agree.
“Who wants to wait in this day and age? You tell me!” says Ann Brill, owner and principal broker of Centum Metrocap Wealth, Inc. “’I want something and I want something now,’ – tell me someone who’s not like that.”
If you’re a prospective homeowner who is no longer able to qualify for a mortgage, or if the mortgage you qualify for isn’t going to buy you the type of home that you want or a home in the location that you want, then you have to make a decision: a) save more money and wait to buy a home until you have enough to qualify for what you want where you want b) buy a smaller home, a different type of home, or a home in a different location than what you originally wanted, or c) go to a private lender to get a loan.
The last option is obviously the riskiest, but what most people don’t realize is that private mortgages aren’t the Be All End All of home loans. The terms tend to be short, which means that you’re going to be forced to reevaluate your situation in a year or so. Sometimes, for example, you can’t get a loan with an “A” lender because you may have great income on paper, but you have spotty payment history or poor credit. So for a year, maybe you suffer through the higher interest rates that comes along with a private mortgage, and in a year or two refinance with another type of mortgage, having improved your payment history and credit. Cash flow, Brill says, is often what kills a deal with an “A” lender. A private deal, however, can function as a stepping stone to something better and more stable.
“It gives you a chance to breathe, get caught up,” she says. Nine months down the road, she’s able to reach out and follow up with the client, make sure that they have followed the plan that they worked out together, and go to a “B” lender. “It’s a one year thing, it gives them an amount of money to do what they have to do and clean them up . . . There’s more opportunity.”
And the opportunity doesn’t stop there; there’s always potential to move up to a better mortgage.
“Look at it from a year ago to today,” Brill says. “Yes, your house was $600,000, yes, it was a ‘B’ deal so the rate might’ve been like, 4.5 per cent or something, but if you bought it last year and this year you did what I told you to do, you can go to the ‘A’ space. You’ve just increased it by $60,000 in market value on your home that you would never have saved in a year, ever.”
If you’re trying to repair your credit similar to the example above, then going with a private lender might be a good way to go. You’re not getting a 25-year mortgage with a private lender; that’s not how those loans are designed to work. Instead, private loans are a short-term vehicle for borrowers, and in the case of prospective homeowners, they can be successfully used as a bridge to a more conventional mortgage.
As to whether or not shadow lending will continue to rise because of the mortgage rule changes, mortgage broker Dave Butler thinks that there are probably fewer people who would end up going to the private space where they would’ve gone to monoline lenders specifically because monoline lenders are still working with high-quality borrowers. As he points out, if an application was getting approved by a monoline lender, then it would be approved by the banks.
“I think it would possibly mean ‘B’ lenders get a tiny bit more business from lazy brokers who aren’t willing to go and try or are feeling like their next hope is a ‘B’ lender,” he says.
If the rules have changed your mortgage prospects and you’re considering getting a private mortgage, here are some situations that getting a private mortgage may make sense:*
- You are purchasing raw land or a unique property that traditional lenders won’t touch because it’s outside their lending criteria;
- You are looking at buying a property to flip or a home that is in major disrepair, and need the funds to do the renovations;
- You need access to equity in your home and the penalty to break your current mortgage is too high;
- You have credit issues such as a consumer proposal or bankruptcy and it is preventing you from getting a mortgage for the full amount that you need from a traditional lender and you need a “top up”;
- You need to consolidate high interest debt, and due to bruised credit, you have been turned down by traditional lenders;
- A divorce, illness or some other life-changing event has had a major negative impact on your credit rating or low income, and you need mortgage financing until you get back on your feet;
- You need to take out equity from your property to get back into good standing with an existing mortgage that is in arrears, power of sale or foreclosure;
- You are interested in purchasing a new home, you have a sizeable down payment, ideally at least 15% of the property value;
- You have an existing property with a small mortgage that leaves you with a fair amount of equity in your property. Ideally you want the total of your existing mortgages and the new one to be at least 85 per cent of your property value or less.
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