Home prices in Canada have risen faster than at any other time in history. Mortgage rules have become stricter, making it harder to qualify for both new homebuyers and those who need to refinance. The Bank of Canada is finally raising interest rates after historic lows.
Getting into (and staying in) the housing market has become much harder and more expensive than it has been in the past. Since the introduction of the stress test to mortgages in Canada, it’s become harder for both new homebuyers and those who need to refinance to qualify for a mortgage to get the loan they need.
Canadians are facing new levels of financial pressure, and that’s leading some to turn to private mortgage lenders instead of the more traditional banks and credit unions.Let’s Talk
What Is Private Lending?
Private lenders can be individuals lending their own money or corporations that use investor capital. They could even be a friend or relative willing to lend money. Private lenders typically offer higher-interest loans, but often they are not as concerned about the borrower’s credit score.
That can make private loans an attractive option for borrowers who have a suboptimal credit score, or who face other challenges with traditional banks, such as the self-employed. You might also consider using a private lender to qualify for a mortgage after your consumer proposal, which can remain on your credit history for years.
While the mortgage works the same as it would if you took it out from a financial institution, private lenders come with a unique set of risks.
Private Lender Mortgage Rates
It is often easier to secure a private mortgage, but that comes at a cost. Mortgage rates from private lenders can be considerably higher than what you would get from a traditional lender. Despite historically low interest rates from the Bank of Canada, private lender mortgage rates can reach the double digits when you include fees, such as a broker commission and set-up fees, often equalling around 1-3% of the loan.
In 2021, the average 5-year fixed rate mortgage on new loans was slightly over 2%. Even the stress test rate, meant to determine affordability in a high-interest environment, was only 5.25%.
In the current environment, any mortgage nearing or in the double digits is extremely expensive to carry.
Who Is Using Private Mortgage Lenders?
While housing prices are running away from the average new buyer’s budget, they’re largely not the ones turning to riskier private mortgage lenders. More often it’s homeowners who are refinancing their mortgages who turn to private lenders in Ontario.
The stress test requires potential borrowers to demonstrate that they could afford to make their mortgage payments at a qualifying rate, not the historically low interest rates presently available. This makes sure that they can still afford their home in a worst-case scenario, where interest rates are higher. This will limit the amount anyone can borrow, unless they are paying more than 20% of the mortgage.
New homebuyers with a poorer credit history might still turn to private lenders to qualify, but the stringent mortgage rules suggest that most people turning to private mortgage lenders are existing homeowners who are renewing their mortgages.
It’s not just homeowners with bad credit who are using private lenders. There is some speculation that many borrowers have good credit and high incomes, but are still living beyond their means and add to their debt every year. In the hot housing market of the GTA, a certain set of homeowners are borrowing off the equity in their home created by rising prices to fund a lifestyle their income can’t support.
Others are homeowners who have poor credit or recently bought their home who need to borrow further funds for renovations. The uptick in unconditional offers that happen without a home inspection means more buyers are faced with unexpected costs right away, often at a time when they’re cash poor.
Another segment turning to mortgages from private lenders are real estate investors who need to refinance their rental properties. The change in mortgage rules and how rental income is considered has made it harder for real estate investors on a single income to qualify for that additional mortgage.
The Risks of Private Lending
One risk about turning to private lending is the duration of the loan. Private mortgages can have shorter terms, and there is a risk that if your credit score has not recovered or credit has become harder to come by, you might be able to obtain any financing when it comes time to renew. There is always a chance that you’ve only delayed the problem by turning to a private mortgage without facing the source of the problem.
The biggest risk, however, is losing your home. Because private lender mortgage rates are so much higher, your monthly payments can be much higher than you’re used to, and it can be easier to fall behind.
With a private lender, falling into mortgage arrears can be very dangerous. Private lenders are often quicker to proceed with foreclosing on a property than banks or credit unions, which typically want to see you keep your home. Not only are they counting on the hot housing market, but liquidation costs and fees can compound what you owe.
How to Protect Your Home When You’re in Debt
Losing your home because of debt is a worst-case scenario, but it is a real possibility if you can’t keep up with your mortgage, whether you borrowed from a bank, credit union, or a private mortgage lender.
If you are in debt trouble and you worry that you could lose your home, it’s time to speak with Licensed Insolvency Trustees in Ontario. Book a free consultation with David Sklar & Associates to talk about your debt situation and the resources available to you for fixing the problem.
Insolvency is often seen a last result, but it can help you avoid an even worse financial situation, especially if you’re dealing with multiple types of debt. Filing bankruptcy or a consumer proposal in Canada does impact your mortgage or any other secured loans. That said, if you’re struggling to pay your mortgage because of other debts, such as payday loans or credit cards, insolvency can help you reset your finances.
If you’re turning to a private mortgage lender because you’re carrying more unsecured debt than you can afford, you could be risking your home when insolvency is a potentially better option. You can keep your home when filing bankruptcy. Home equity up to a certain limit is exempt from bankruptcy proceedings, and all of your assets are protected in a consumer proposal.
Insolvency can also be useful after a foreclosure. There are some cases where even if your mortgage lender initiates a power of sale proceeding, you can still walk away with mortgage-related debt. When there is a power of sale proceeding, the lender attempts to sell the property for the full value of the outstanding mortgage. If they are unsuccessful, there can be a deficiency. This is the difference between your outstanding balance and the proceeds from the property.
However, the deficiency becomes unsecured debt after a power of sale proceeding, because there is no longer any collateral. That amount can be included in bankruptcy or a consumer proposal, giving you a way out of the debt.
Can a Consumer Proposal Help with a Home Equity Loan?
Turning to a private mortgage when you refinance is not the only way you can put your home in jeopardy due to debt. A home equity line of credit (HELOC) is a secured loan that uses equity in your home as leverage.
As you make progress paying down your mortgage, or when your home rises in value, you gain equity that you can borrow against, even if you’re still paying your current mortgage – which is why HELOCs are sometimes called second mortgages.
However, like a mortgage, if you are unable to repay it, the lender can seize your home. When it comes to consumer proposals and home equity loans, the unfortunate news is that insolvency cannot clear secured debts such as HELOCs. What they can do is reduce other debts such as credit cards, payday loans, or even tax debts, potentially freeing up money that you can use to keep up with mortgage and HELOC payments.
Turning to a mortgage from private lenders can be a risky financial decision. Private mortgages tend to be more expensive, with much higher interest rates, and private lenders tend to be much quicker to enforce payment delinquency. Before using a private lender, consider tackling the root of your financial problems, whether that’s dealing with mounting debt or repairing your credit score.