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Whether you’re a consumer who requires a temporary fix or a real estate investor who owns multiple properties, private lending can help you reach your property goals.
With the credit crunch, and subprime lending coming to a sudden halt, the private lending option for obtaining mortgages or refinancing has increasingly become of interest to property purchasers.
Private lending also allows investors to lend out their own funds to help others obtain a mortgage or refinance.
The lowdown on private funds
Consumers who don’t fit typical bank lending criteria include: those who have a credit blemish as a result of such events as divorce or job loss, and are trying to rebuild their credit rating; self-employed borrowers having trouble proving income; borrowers new to Canada who haven’t yet built a credit history; and those who own multiple properties.
Private lenders use only two tools: investor money or mortgage investment corporations (MICs), which are funded pools. MICs are audited by the securities commission and the provincial governing body, says Chuck McKitrick, CEO of private lending firm Alta West Mortgage, based in Calgary. Alta West lends private funds through its MICs and private investors.
“We try and keep everything in the MIC because we want to keep the MIC fully invested. But it might be a unique deal and we might have an investor that likes that unique type of deal,” he says.
Capital Direct Lending Corp is a private lender that has been in business for 11 years. The company is a bit different in that it funds its own mortgages and doesn’t use MICs.
“We have our own money that we use to fund the mortgages. We’ll sell the mortgages off after we fund them,” explains Matt Oberle, the company’s business development manager.
Accessing private funds
Mortgage brokers and agents are your easiest link to most private lenders. It’s best to approach a broker with expertise in this area because he or she will have experience in reading appraisals and determining if your loan is fundable. A broker will want to know three things before taking your deal to a private lender: purpose of your loan; plausibility of your loan; and your chances of being able to pay instalments on time.
David O’Gorman, mortgage broker/owner of MortgageLand Inc in Markham, Ontario, predominantly deals in private funding. MortgageLand has a portfolio of private investors, and O’Gorman manages the loans and the private lenders administer them. He says there’s a story to every borrower who uses private lending. “If there wasn’t a story, they’d be going into an institution to get their money,” he says. “But the institution has to live within guidelines. We don’t have those guidelines, but you don’t lend money to someone that can’t pay it back…”
As private loans are riskier ventures for lenders, you’ll pay higher interest rates and possibly broker/lender fees, and the term of your private mortgage won’t exceed a year. The mortgage is renewable in one-year intervals if your financial situation doesn’t improve enough to bring you up to the standards required by prime or alternative lenders.
There are two reasons for the shorter terms, says McKitrick. One is that private investors don’t want their money tied up long term. The second is to allow borrowers to get into a lower interest mortgage as soon as possible.
Other attractions of private lending include the speed and ease of funding a loan, says Everton Peterkin, president of Royal Commercial Mortgage, a residential and commercial mortgage brokerage based in Toronto.
“Borrowers are never constrained by rules as to how many mortgages they can have in their name,” Peterkin says. “In fact, none of these mortgages ever show up on their credit report. In turn, private lenders receive higher interest rates and fees with a very secure investment.”
Focus on real estate
Although applying for a private mortgage doesn’t differ much from applying for a prime mortgage, the focus differs. The main focal point of private lending is the real estate, while prime lenders zero in on the borrower. In other words, credit scores aren’t a big concern when you’re seeking a private mortgage, as long as there’s a lot of value in the property, the home is in good condition and you have a reasonable likelihood of being able to pay off the loan.
“Banks care more about where you’re coming from and what you’ve done in the past,” says Capital Direct’s Oberle. “We’re looking more in the future – how this guy is going to make his payments going forward, not if he’s made his payments in the past.”
Although most private lenders are willing to fund mortgages in more rural areas, interest rates rise because of the rise in risk. “If we’re going to go to those rural places, we want to make sure it’s one of the best homes in that area,” says Hali Strandlund, president of private lending firm Fisgard Capital Corporation in Victoria. Private lenders will also take a close look at the economic development in the area, find out what’s happening and why someone would want to be there, she adds.
The loan to value (LTV) is the amount of the loan in proportion to the amount of the downpayment. LTV changes according to risk in rural areas.
“In inner-city Calgary, a property would turn over very rapidly, so we would be willing to go to 85%, whereas in small-town Alberta, we would look at what’s in that town and we might only go to 65%,” says McKitrick.
Seek an upfront broker
You want your broker to be upfront if you’re going to have to get a private loan at a higher rate as a temporary solution. This helps you avoid interest rate/fee shock down the road.
It’s also imperative to check exit fees. Some private lenders offer lower interest rates, which can be deceiving if they require up to nine months’ interest if you pay out your mortgage early. Check with your broker to ensure you can pay the loan out early without penalties if your financial situation improves before the term of the private loan expires.
Your broker should also be willing to write out a comparison of calculations to ensure you understand the reasons for different interest rates based on risk, and the possibility of broker/lender’s fees and early payment penalties.
Case study: Laura Jackman, Ontario
Five years ago Laura Jackman found the perfect property to start her dream business of breeding and training horses. The 40-acre farm in Uxbridge, ON, had a 20-stall barn but no house, so a traditional mortgage wasn’t an option. “As soon as we told them there was no house on the property, the banks wouldn’t touch us,” says Laura, who purchased the property with her family for just over $400,000. “So in order for us to obtain a mortgage we had to go and find somebody who had enough money and was willing to invest in us.”
She found a lender through the family’s real estate lawyer and had to present a complete business plan for review. In the end, she received the financing, but at a price. “I paid an interest rate of 12%, which was about six points above prime at the time,” she says. “I got the money but it was on [the lender’s] terms … The loan was renegotiable every year and at the end of each year they could recall the loan with a year’s grace period.”
This meant that every year Laura was on pins and needles wondering if the private lender would call in the loan, and, in her fourth year of operation, it happened. “Last year they called in the loan and I ended up having to approach the bank for a mortgage,” she says. “But now I actually had something to show them. I had an established business that was earning money so the bank was willing to negotiate with us.”
Since her farm is no longer considered a start-up business, Laura was able to secure a mortgage from TD Canada Trust at prime plus two – a far cry from her original 12% interest rate. “I couldn’t have done it without the private lender. It would have been shut out to us,” she says.
Cindy Freiman is the editor of CRE’s sister publication Canadian Mortgage Professional (CMP) (www.canadianmortgageprofessional.com)