Most Canadians require a mortgage to buy a home. But the process of getting approved for a mortgage isn’t easy. You need to be in good financial health and meet requirements for income, debt, and credit score. So, what happens if you aren’t? In some cases, a private mortgage could be an alternative that will help you achieve your home ownership goals.
» MORE: How do mortgages work?
What is a private mortgage and how does it work?
A private mortgage is a loan offered by an individual or institution to prospective homebuyers who are unable to secure a traditional loan from a financial institution, like a bank. These loans are similar to subprime mortgages.
Home buyers may look to private mortgages if they have poor credit history and don’t qualify for traditional loans based on the regulations of other mortgage lenders. Private lenders are more likely to see the mortgage as an investment and therefore aren’t as strict regarding credit history and background checks. A private mortgage may also make sense if you’re buying a unique type of house, you don’t plan to own the property for very long, or you have a non-traditional source of income.
Private loans are often short-term, with typical amortization periods lasting six months to three years. It’s thought that, after making on-time payments over this term, the borrower will be in a better position to apply for a mortgage from a traditional lender.
The interest rates offered by private mortgage lenders tend to be significantly higher than those offered by traditional lenders, but mainly because the payments you’ll make on this type of loan are interest-only. With an interest-only mortgage, none of your payment goes towards the principal, so the total amount owed does not get smaller over time, as it would with a typical mortgage.
The process of getting a private mortgage can be much faster and easier than qualifying for a traditional mortgage. But know that those benefits come with higher interest rates, fees, and potentially more risk.
How to get a private mortgage
Private mortgages are offered by individuals, syndicates, and mortgage investment corporations. An experienced mortgage broker may be able to put you in touch with a reputable private lender, or you can search for one yourself.
While getting a private mortgage is generally faster and easier than qualifying for a mortgage with a bank, you’ll still have to meet some eligibility requirements. To qualify for a private mortgage, you need to have:
- Proof of income: You’ll need to demonstrate that you have the income necessary to make mortgage payments. This can be tricky if you’re self-employed, and you may be required to provide extra documents.
- Down payment: Usually you’ll need a minimum down payment of 15% of the purchase price to get a private mortgage.
- A sellable property: If the borrower defaults on payments, the lender will want to be able to take possession of and even sell the property to recoup their investment.
When is it a good idea to get a private mortgage?
While a private mortgage has a shorter amortization period, and higher rates and fees compared to a traditional mortgage, there are some circumstances in which it might be worth considering:
- You have poor credit history and traditional lenders won’t approve you for a mortgage, or won’t approve you for enough funds to buy a property in your area.
- You need the money quickly and don’t have time to go through a traditional lender’s approval process.
- The property you want to purchase is unconventional, so a traditional lender will not finance it. Perhaps you have your eye on a fixer-upper, inherited a home in disrepair and need help with construction costs, or want to buy a commercial property, vacant land, or a home in a rural area — a bank might be wary of your application.
- You just need a short-term loan until you’re in a better position to secure funding from a traditional lender.
- You are unable to confirm your income to meet the requirements for a traditional mortgage.
- You’re a newcomer to Canada who can’t fulfill the standards of traditional lenders. Foreign income, foreign credit history and a short Canadian employment history might make it difficult to be approved by traditional lenders.
- You’re self-employed and have irregular income.
» MORE: How much mortgage can I afford?
Private mortgage pros and cons
Private mortgages may be useful in some situations, but they’re not for everyone. Here are the main pros and cons to be aware of when it comes to private mortgages.
- A faster approval process.
- Suitable for people with poor or little credit history.
- Open to people who don’t have traditional sources of income.
- Higher interest rates.
- Additional fees for setup and commissions.
- Interest-only payments don’t help you pay down your mortgage
- Private lenders are not licensed, so you can’t be sure if they have the same education, experience and suitability requirements as licensed mortgage professionals.
- Harsh implications if you get behind on payments. Private mortgage lenders will foreclose on a home more quickly than a bank.
Alternatives to private mortgages
If you don’t qualify for a traditional mortgage, and you can’t get or don’t want a private mortgage, consider these alternatives.
Get a co-signer
Friends or family members who co-sign a mortgage add the strength of their financial profile while also assuming responsibility for payments if you fall behind. Co-signers can make it possible to get approved for a traditional mortgage if your individual income and credit score don’t meet lender requirements.
These types of programs are structured as a long lease with an option to buy the property at the end of a specified term. The idea is that you can move into the home immediately, but you have a longer time to save up and get into a better financial position to apply for a mortgage at the end of the lease.
Multiple collateral mortgages
These require a second property to secure the mortgage, typically the home of a friend or family member. Having the extra collateral will make it easier for you to qualify for a loan, but both parties are now responsible for it. If either party defaults, both homes will be at risk, so carefully evaluate other options before considering this one.
» MORE: What is a collateral mortgage?
This option isn’t common, but you may be able to negotiate flexible terms with the seller. The most popular example of seller financing is a Vendor Take Back (VTB) mortgage, in which they hold a loan for part of the sale price. However, the interest rate may be higher than for a traditional mortgage and you’ll need to find a mortgage lender that will allow this type of deal.
Wait until you can qualify
Sometimes the best thing to do is pause your house hunt. Take the time to get your financial health in order, pay off more of your debt, build a better credit score, and save up a larger down payment. When your finances are in better shape, you may be able to qualify for a mortgage with a traditional lender.