Most borrowers – real estate investors included – think of private lenders as a last-resort option if they can’t secure financing anywhere else. But private funds have gained traction as a financing option due to mortgage rules set by the federal government and the continued caution being exercised by institutional lenders.
Who needs private funding?
“What we’ve seen in this marketplace is a big resurgence on the investment property side,” says Chuck McKitrick, CEO of Alta West Capital, a private lending company based in Calgary. “There are all these investors rolling back into the marketplace and they’re tired of dealing with the banks’ stringent parameters, meaning they’re fine with private money because it’s quick and easy even though it’s more expensive.”
Carmen Capagnaro, president of Pro Funds Mortgages, says she sees a significant demand for private financing, particularly for higher ratio, smaller investment properties like single-family homes and condo units used for rental income purposes.
“Not everyone can come up with a 20 per cent down payment, so one of the options is private money,” she says. “Anyone who is buying in that smaller category has the ability to get up to 90 per cent financing with private funds as opposed to 80 per cent with a traditional lender.”
Something else that might drive real estate investors to private lenders are the CMHC insurance rules for self-employed borrowers. These rules state that Business for Self (BFS) borrowers with more than three years in the same business, as well as commissioned-income borrowers, are required to provide traditional proof of income (or “third-party validation”) to qualify for a loan. Those who have recently become self-employed and don’t have third-party validation can still apply for a mortgage, but have to come up with a 10 per cent down payment.
“Self-employed is where we make most of our deals, because they make enough money but they write everything off so they can’t qualify [for conventional mortgages],” says Tim Hurlbut, business development officer for Alta West Capital. “There’s a plethora of reasons we’re more valuable – for people who have lots of properties, yes, but also for people with poor credit. That’s more the niche product that we offer.”
So if you’re a property investor who needs fast cash, a self-employed borrower who is confident that you have the income or someone with poor credit who won’t qualify with a traditional lender, a private mortgage is an option for you.
Explaining private mortgages
Private mortgage lenders operate differently from banks and other mortgage lenders on many levels. One of the major differences is their source of funding: private mortgage lenders get their money through individual investors or groups of investors. Some larger lenders have several different funding sources, or include a pool of mortgages called a MIC (mortgage investment corporation) while smaller investors might simply lend out their own money. In both cases, the private mortgage is seen as a short-term investment that can be sold off within a year or two as opposed to something to keep on a balance sheet.
Another difference between bank mortgages and private mortgages is the application process. Instead of the borrower being scrutinized, the property is what gets the most attention from a private lender. This is because private loans are uninsured, meaning the lender must fall back on the property should a default occur. For this reason, properties in smaller towns or rural areas likely won’t qualify for as much money with a private lender – 65 per cent LTV compared to 85 per cent in an urban centre, for example.
“Our primary criteria is the condition the property is in, where it’s located and how easy it is to sell if the borrower gets into trouble. If that fits, we look at the character of the client, their ability to repay, and the purpose of funds,” says McKitrick, adding Alta West doesn’t often verify borrower income, which can be attractive to many real estate investors.
Uses for private funds
While they can be used for purchases of property, one of the most popular borrower uses of private funds is for second mortgages. A second mortgage can supplement bank financing ( as many banks do not grant second mortgages). This could be the case if the borrower qualifies for 75 per cent LTV on a second mortgage from a bank, but needs and extra 10 per cent to purchase a property.
Real estate investors turn to private money lenders for a variety of reasons. A common scenario McKitrick sees is an investor who does “fix and flips” and only needs money for a short period of time before re-selling a property.
Another instance is when the investor wants to buy a distressed property – a foreclosure, for example – and fix it up. Because banks often won’t touch these types of properties, an investor can buy with private funds and once the property is fixed and producing a cash flow, they can access cheaper funds from an institutional lender.
“For the investor, we’re often seen as that short term solution – we’re a stop-gap,” McKitrick says.
Property investors might also find themselves in a situation where their investment property is not bringing in the current market value for rent and may need time to renegotiate leases or complete renovations that will allow them to charge tenants higher rents. In this case, they could take out a second mortgage with a private lender and once the issue is solved, they could find more conventional financing elsewhere.
Another reason for getting private loans could simply be that a borrower is turned away from the bank for having too many properties in their portfolio.
Private lenders are also an option if you want to build instead of buying resale. “It all comes down to how much money you have,” says Hurlbut. “Construction’s not for poor people, unfortunately.”
Although private mortgages can help borrowers get out of sticky situations or provide temporarily relief until the borrower can obtain a mortgage from a traditional lender, there are additional costs to consider.
First up is the higher interest rate, which can range from a couple of percentage points above a bank loan to upwards of 20 per cent. Lenders weigh the interest rate based on the loan to value needed, the property location and the overall risk factor of the loan. Campagnaro says most private lenders she works with charge between a 12 per cent and 15 per cent interest rate for a 90 per cent LTV mortgage, but she stresses that many of those lenders still only want to go up to a 80 or 85 per cent LTV. Since interest on income-producing properties is tax-deductible, it can provide relief from higher interest rates.
Other costs borrowers have to be aware of with a private mortgage are lender fees, mortgage broker fees, legal fees and an appraisal if a recent one isn’t available.
“Typically, private lenders charge a fee of two per cent of the loan, but I’ve seen in some cases if the loan is under $50,000, the lender fees go up five per cent,” says Campagnaro, adding the general rule is the higher the LTV on a private mortgage, the higher the fee.
Mortgage broker fees will generally be similar to the lender fee, and often times there are also additional charges for pulling out of a private mortgage early, although terms generally don’t exceed a year.
For legal fees, Campagnaro says borrowers have to pay for both their own lawyer and the lender’s lawyer, which can add another couple of thousand dollars to the tab. While in some cases a lender can roll these fees into the mortgage, others might not be so accommodating, so be sure to check beforehand. Also make sure to ask about the fees if you’re not sure about them – it’s a lender’s obligation to disclose all the costs associated with a mortgage before you take one out.
Where to start
While it’s possible for consumers to directly access some private lenders, most borrowers looking for these types of funds go through a mortgage broker who has connections to a wide variety of private lenders and investors.
To find a broker, try asking for recommendations from other real estate investors or check with your bank to see if they know any brokers who deal with private funds. Once you’ve found someone, McKitrick recommends asking lots of questions and making sure they have adequate experience.
“A client should interview several mortgage associates and see what kind of history they have in private lending and then, just like they would with any trade, they should do their due diligence in determining how good they are,” he says.
After you’ve nailed down a broker, they will want to know the purpose of your loan (purchase, consolidation, bridge financing, construction, etc.), the plausibility of the loan (as determined by details on the loan application), and your chances of being able to make the loan payments on time. They will structure the deal and help plan an exit strategy so the borrower won’t have to stay in a private mortgage for a long period of time. It’s also important to note that some private lenders will renew mortgages after a one- or two-year term if the payments are good and the borrower needs to stay in the mortgage for longer. The situation isn’t ideal, but Campagnaro says it can be manageable if a property is producing income and there is a cushion to pay the higher interest rate.
“At the end of the day, borrowers have to make sure their numbers work with this higher-interest mortgage – the property still has to cash flow,” she says, adding borrowers should have some extra cash in their operating accounts that could cover the asset for a couple of months should something unexpected happen.
Whatever the case, knowing the private money option is available is helpful when navigating the strict mortgage insurance rules and restrictions for real estate investors and self-employed borrowers. Understanding it as a short-term solution can make the extra costs easier to swallow – especially if it means acquiring a great property that might have been out of reach without the help of a non-institutional lender’s funds.
Three tricks for working with private lenders in Canada:
- Be cautious. Don’t rush when you’re signing a contract and make sure you feel comfortable with the terms. Ask questions of your broker, and if it’s a smaller private lender, don’t be afraid to ask for references. Also, make sure your lawyer reviews your contract before signing anything.
- Plan your exit strategy. With your broker, plan how to secure other financing in a relatively short period of time – private lenders don’t want to be tied to a mortgage for more than a year or two, so the idea is to use them as a “bridge” on the way to a more traditional lender with lower interest rates.
- Know the costs. The mortgage broker and lender will both charge fees for private deals and there are also legal fees. Remember to factor these costs in your budget and get percentages in writing. Also be sure to check what the exit fee (or prepayment penalty) is so you know what to expect if you decide to pay out the mortgage before the term expires.
Here are just a few of the alternative lenders who offer private financing in Canada. Contact your mortgage broker to find more that may be right for you.
ALTA WEST MORTGAGE
Interest rates: Seven to 16 per cent
Maximum LTV: 85 per cent
Terms: One year, interest-only payments or 25-40 year amortizations
Minimum loan amount: $10,000
Maximum loan amount: $2,500,000
Provinces served: Alberta, Ontario, and B.C.
Market focus: Owner-occupied, single family residential and investment properties
Fees: Two per cent to five per cent of the loan value, depending on risk factors and loan size
CANADIAN MORTGAGES INC
Interest Rates: 5.99 to 14%
Maximum LTV: 80%, 85% on exception in urban cities with strong covenants
Terms: 12 month, interest only (default), custom terms available upon request
Minimum Loan Amount: $25,000
Maximum Loan Amount: $3M~ in GTA, lower in other centres
Provinces Served: ON, BC, AB, MB
Market Focus: Single Family Owner Occupied, Rentals Up to 4 Units, Multi-Family or Multi-Unit Income in GVA or GTA
Fees: 1% to 3% and up on 1st mortgages (size, location, LTV dependant), 2nd mortgages 2 to 5% and up (size, location, LTV dependant)
CAPITAL DIRECT LENDING
Interest rates: 6 to 20 per cent (first mortgage rate, second mortgage rates and third mortgages)
Maximum LTV: 79 per cent
Terms: One year (can be longer with rate increase)
Minimum loan amount: $10,000
Maximum loan amount: $750,000
Provinces served: B.C., Alberta, Ontario, Nova Scotia, New Brunswick, and P.E.I.
Market focus: Single family dwelling, condos, recreational properties, multi-unit residential, rooming housing, farms, vacant land and more.
Fees: 3 per cent and up
Interest rates: 8 to 16 per cent
Maximum LTV: 85 per cent in major urban centres (currently in Alberta only)
Terms: typically 12 month term but can be longer
Minimum loan amount: $25,000
Maximum loan amount: None
Provinces served: Alberta, BC and Saskatchewan
Market preference: residential, commercial, retail, industrial, multifamily, and acreage properties
Fees: 2% on first mortgages and 3% on second mortgages, with a minimum fee of $3500
FISGARD CAPITAL CORPORATION
Interest rates: Private mortgage rates start at 5.99 per cent
Maximum LTV: 75 per cent
Terms: Two year maximum
Minimum loan amount: No minimum
Maximum loan amount: $5,000,000 (note: depends on the deal presented and borrower’s history with Fisgard)
Provinces served: B.C., Alberta, Saskatchewan, and Manitoba
Market focus: Single-family residential properties, owner-occupied or investment properties including multi-family and apartment buildings, single family construction and income-producing commercial properties
Fees: One to three per cent of the loan value
TRIBECCA FINANCE CORPORATION
Interest rates: 7.99% to 13.99%
Maximum LTV: 85%
Terms: 1 month to 2 years
Minimum loan amount: $10,000
Maximum loan amount: $2,000,000
Provinces served: Ontario
Market focus: Residential 1st & 2nd mortgages and construction mortgages
Fees: Starting at 2%
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