Private mortgage lenders have been a saving grace for real estate investors who don’t always fit bank criteria because, for example, they own a high number of properties. While they continue to be a viable option, the industry has seen some big changes over the past few years due to the shifting economic climate.
First was the disappearance of subprime mortgage lenders, leaving “non-A” clients with fewer borrowing options. This shake-up was followed by a sharp decline in housing values and credit availability from conventional lending institutions. Throw in updated rules on private lending (in certain provinces), investor uncertainty and a growing number of property foreclosures and mortgage defaults and it’s easy to see why the landscape looks different.
“Generally, private money lenders have become more conservative and careful and some have gotten out of the market completely, which I think is a good thing,” says Rajan Kaushal, president of The Money Source, a private lending company in Toronto. “I think serviceability has become more of an issue and we’re doing more due diligence now.”
Matt Oberle is a business development manager at the private lender Capital Direct, which has offices across Canada. He says he has also noticed a more cautious approach, adding his company is lending less due to tightened credit.
“We have to turn more clients down,” he says. “We’re still subject to what the banks and financial institutions offer because they’re the ones that ultimately have to pay out our mortgages when a client improves their situation.”
And while mortgage investment corporations (MICs) were popular business ventures in recent years, several smaller private investors have backed out of the market since being presented with economic challenges, leaving more established private lenders a larger share of potential borrowers.
Why choose private money lenders?
Private lenders get their money from two sources - investor money or mortgage investment corporations - and are typically seen as short term investments that can be sold off within a year or two.
Interest rates on private mortgages are higher than conventional mortgages so they’re seen as an alternative for borrowers who can’t secure a loan from other lenders, allowing them to fix a credit problem over a relatively short period of time, gain capital to invest in more properties or renovate existing ones.
For example, real estate investors can run into challenges with banks if they have a high number of properties in their portfolio because the bank may put a cap on how much they want to lend. This situation is more common in the new climate of tightened credit and borrowing criteria.
“Under bank guidelines, once you’ve purchased a lot of properties to rent out, it will eventually be more difficult to qualify for further mortgages, or the banks will cut back their loan-to-value,” says Kaushal, who also funds renovation projects for investors who flip houses. “That’s where second mortgage financing on investment properties comes into play because borrowers might not have enough of a down payment to purchase another property.”
Oberle says real estate investors may want to go to a private lender not only because they’re not going to be limited on their number of properties, but because the process is typically faster and easier. He also points out that the interest on rental properties is tax-deductible, which can compensate for some of the cost of higher interest rates.
“A bank will not only want appraisals, they’ll want a record of mortgage payments, they’ll want rents, they’ll want lease agreements, whereas we just look at the property we’re lending on,” he says. “It’s a lot simpler for somebody to go through us if they have a portfolio of properties.”
Investors might also find themselves in a situation where their investment property is not bringing in the current market value of rent and may need time to renegotiate leases or complete renovations that will allow them to charge tenants higher rents. Once this issue is solved, property owners can often find conventional financing and go back to paying lower interest rates.
The new economic situation means many private lenders have implemented changes to reduce their risks, even though this equates to lower payouts for investors. A common scale-back has been lower loan-to-value ratios on mortgages.
“We’ve decreased our loan-to-values and that’s because we’re an equity-based market and we have no insurer behind us - we have to self-insure and so we have to protect ourselves that way,” says Chuck McKitrick, owner and partner at Alta West. He adds that some deals are being scrutinized more closely depending on the property, such as condos in Edmonton, which recently took a hit in the real estate market.
Capital Direct Lending and Fisgard Capital Corporation have also reduced their LTV ratios to safeguard against further housing value drops, especially since both companies have been increasing their client bases in the residential market. Fisgard president Hali Strandlund, who is based in Victoria, B.C., says while the company might have gone to 85% LTV a year ago, it has lowered that number to 75% on owner-occupied single family residential mortgages and 65% on rental properties. Oberle says Capital Direct has dropped its LTV ratio from 90 to 70%.
Decreasing home values have also resulted in private lenders looking at a borrower’s financial history more carefully. While they’re still more flexible than institutional lenders - most notably when it comes to beacon scores and employment - a client’s ability to pay has become more important in determining if a deal will close.
“When values were going up and up, the [borrower’s] ability to pay was important but not paramount, whereas now we look at that very closely,” says Strandlund. “We’re looking at the serviceability of the loan as opposed to the straight equity.”
In addition, risky borrowers who may have obtained second mortgages or other higher yield loans in the past are also being overlooked more often due to the less stable economy and the demise of the subprime mortgage market, which has given private money lenders new - and, in some cases, less risky - business. For example, McKitrick says borrowers in foreclosure are not being considered at this time even though Alta West used to deal with those types of clients.
With subprime mortgage lenders out of the picture, McKitrick says the competition for subprime borrowers has increased between private lenders and alternative lenders, resulting in lower private lending interest rates. At Alta West, these rates start at 8.99% for first mortgages - only about 1% higher than many alternative lenders, McKitrick says.
“The loss of all the subprime lenders has opened up more territory for us,” he says. “We’re seeing a much better class of borrowers than we did a year or two ago because those deals, which would historically go to the subprime lenders, are now coming to us.”
Fisgard, which was recently approved as a Royal Bank alternative lender, charges interest rates as low as 6.99% for investment properties depending on the situation, says Strandlund, adding the mortgage investment corporation’s rates are competitive with larger lenders. This makes them an attractive alternative to property investors who can’t get financing elsewhere.
“We are another source of mortgage funds for consumers even though we don’t happen to be your typical conventional lenders,” she says. “We’ll look at any deal and price it accordingly.”
Working with private lenders
Most property investors will benefit from getting a mortgage broker to secure private financing, as many private lenders also prefer (or require) a broker to bring them clients because they know how to package deals and add an extra step of due diligence to the process.
Whether working with a broker or approaching a lender directly, full disclosure is important when applying for a private mortgage. These lenders look beyond the numbers to understand exactly why a borrower is in their current position and what problems they’re looking to fix.
“For a private deal, we want the usual details and we also want the story,” says Strandlund, adding it’s essential that clients provide accurate information. “Why are the borrowers coming to us? What other lenders have they already been too? Why did these lenders not approve them?”
For real estate investors in particular, Fisgard also considers the market value of the property, current market rental rates and the borrower’s overall financial strength.
“It’s imperative to us that the investor be able to service the debt in the event of a vacancy,” says Strandlund.
Documents a private lender may require range from the standard (credit reports and appraisals) to the more specific, like land titles and comparative market analyses from Realtors. If an investor is looking for private funds
to complete a renovation, a private lender will also look for things like the viability of the construction, the budget, and the expected time period for completion.
Graeme Moss, a broker and manager with Fair Mortgage Solutions in Hamilton, Ont., who lends privately and works with several private lending
companies, says along with providing the correct documentation, honesty is paramount to building a good relationship with a non-conventional lender.
“If you’ve got a situation that could be a little wonky or imperfect, but it still makes common sense, you’re better to present that wonky situation and let the lender deal with it rather than presenting a sugar-coated situation that appears wonky later on - that could kill the deal,” he says.
Moss also points out that brokers should help clients define their exit strategy when working with a private lender because it’s not a situation that the borrower should be in for the long term. A private lender also wants to be paid out in a relatively short period of time due to the nature of the investment.
Perhaps the most important thing to keep in mind when exploring private lending is that these lenders each have specific niches and requirements, their most common thread being that they should not be lumped in with conventional mortgage lenders.
As Oberle puts it, “We’re a completely different business than A lenders, so there’s going to be completely different expectations on our end. All private lenders are going to have their own guidelines, they’re all going to deal with a part of the market they’re comfortable with, and there’s not going to be a lot of consistency.”
With limited credit available from conventional lenders and more risk-averse practices taking prominence when it comes to banking and real estate, it’s becoming increasingly important for consumers to understand the role of private lenders and know when using one is beneficial. Private lending remains important because it services niche markets like second mortgages and construction financing, not to mention borrowers shut out of the market after the disappearance of subprime lenders. And while working with a new type of mortgage lender can be intimidating, Moss says openness is the best policy to keep in mind.
“The biggest thing is transparency,” he says. “As long as a private lender knows what they’re dealing with and knows the pros and cons, that’s the key thing for a deal to be approved.”
Five tips for working with private lenders
Tell the whole story Be thorough and honest when it comes to explaining your financial situation. Don’t leave any skeletons in the closet.
Have an exit strategy in mind Work with your broker to set a plan to have other financing secured in a relatively short period of time - private lenders typically won’t want to be tied to a mortgage for more than a year or two.
Check ahead Ask your broker or the lender to see what documents and equity information they require.All private lenders operate differently and want to see different criteria.
Ask about fees Both the broker and lender will charge fees for private deals, so remember to factor this into other costs, and be sure to get it in writing.
Be patient Most private lenders have increased their due diligence practices, meaning it might take more time for a deal to be approved.
Private Money Lenders
A snapshot of four private money lenders from across Canada (note, the fees listed below are in addition to the interest charge)
The Money Source
Interest rates: 12 to 16%
Maximum LTV: 85%
Terms: One and two year, blended or interest-only payments
Minimum loan amount: $10,000
Maximum loan amount: $250,000
Provinces served: Ontario (the Greater Toronto Area)
Market preference: Owner-occupied residential properties and rentals
Fees: 2-5% (of the loan value)
Alta West Mortgage
Interest rates: 8 to 25%
Maximum LTV: 65 to 75%
Terms: One year, interest-only payments
Minimum loan amount: $10,000
Maximum loan amount: $2,000,000
Provinces served: Alberta and B.C.
Market focus: Owner occupied, single family residential properties
Fees: 3 to 15% depending on risk factors and loan size
Interest rates: 6.99 to 12.5%
Maximum LTV: 65%
Terms: One year maximum
Minimum: No minimum
Maximum: $5,000,000 (note: depends on the deal presented and borrower’s history with Fisgard)
Provinces served: B.C., Alberta, Saskatchewan, Manitoba, Ontario, Quebec (focus on Western Canada)
Market focus: Owner-occupied, single-family residential properties, as well as multi-family properties and apartment buildings
Interest rates: 7.75 to 20%
Maximum LTV: 70%
Terms: One year (can be longer with rate increase)
Provinces served: BC, Alberta, Ontario, Nova Scotia, New Brunswick, PEI (note: guidelines vary in Atlantic provinces)
Market focus: All residential
Fees: 12% (brokers get a discounted fee)
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