If you’re in the market for a mortgage loan, you’ve probably encountered articles about private lending. But what is private lending, and what are private lenders for real estate? To understand the former, you first need to understand the latter.
Types of Mortgage Lenders
In Canada, there are a variety of types of lenders that you can approach to Generally, lenders are split into three categories:
- A lenders (or prime lenders)
- B lenders (or subprime lenders)
- C lenders (private or alternative lenders)
Prime lenders are banks — large, federally regulated financial institutions that can offer prime mortgage rates to those with good credit and who can pass regulated stress tests.
Subprime lenders are technically any lender that can provide loans to people with bad credit scores. These can include smaller financial entities like provincially regulated credit unions and trust companies, or private lenders. These lenders can offer mortgages in a similar structure to banks, though often with slightly higher interest rates and other restrictions. Credit unions and trusts have slightly more flexibility than banks. The better your credit rating, the lower the interest rate you can feasibly be approved for. Subprime lenders entities can still offer loans to those with very poor credit, but with much higher interest rates.
Private lenders can be any of the following:
- Mortgage Syndicates
- Mortgage Investment Corporations (MICs)
An individual lender is a single person with their own private fund of investment capital. They are choosing to invest this money into loans such as mortgage loans. While an individual can lend out numerous mortgages or other loans at once (depending on how much capital they control), when you borrow from an individual you know that the entirety of your mortgage amount is coming from one place.
A mortgage syndicate is a small group of private investors who decide to share the financial load of investing in mortgages. In a mortgage syndicate, individual lenders can pick and choose which mortgage loans they want to contribute to, and how much. Because each investor contributes a smaller fraction of the total cost of each mortgage loan, they can diversify their investment portfolios more and mitigate the risk. Sometimes, this means that fees and interest rates can be more flexible.
Mortgage Investment Corporations
An MIC is something like a bigger version of a syndicate. This is a much larger group of individual investors who pool their investment capital into an incorporated structure for the purpose of loaning out many mortgages at once. Another big difference between an MIC and a syndicate is that, unlike in a syndicate, the members of an MIC don’t necessarily get to choose who to lend to. Rather, the capital is pooled and the corporation as an entity will either approve or reject applicants.
Why Borrow from a Private Lender?
The most common reason for borrowing from a private lender is that you can’t get approved by a bank or credit union. Often this is due to a low credit rating, or low income. You may have bad credit due to previous financial hardships, a previous bankruptcy filing, or simply because you haven’t used enough banking services to build up good credit.
Likewise, if you are self-employed or have income that fluctuates or is difficult to prove on paper, banks may turn you down simply because you can’t prove your income well enough to meet those strict government guidelines.
A third scenario might be that you are looking for a mortgage structure that banks can’t offer, such as a second mortgage.
In any of these cases, a private lender is your best bet for securing a loan against your property.
How do Private Money Lenders Work?
Private lenders aren’t subject to the same strict regulations as banks. Due to federal laws, banks have to look first and foremost at an applicant’s financial history and situation. If you’re applying for a mortgage at a bank, you need to be able to prove that you can pay it back — by showing that you have a strong track record of paying back previous debts. You’ll need a strong credit rating (usually at least 600), as well as documents like records of employment, tax returns, and investment certificates to demonstrate your good financial standing.
Private money lenders, on the other hand, don’t need to focus as much on your financial history. Instead, when it comes to mortgages, they prefer to examine the value of the property. Provided that the property has at least 20-25 percent existing equity — that is, value that has been paid up front, or paid off an existing mortgage — you can get approved for a loan by a private lender.
This doesn’t mean that a mortgage from a private lender is free money. Since lending to those with poor credit or uncertain finances is inherently risky, private lenders usually charge significantly higher interest rates than banks to help mitigate that risk. You’re still responsible for paying off the loan on time, and keeping your own financial house in order.
How do You Find a Private Lender?
If you’re now wondering how to find private money lenders, the best answer is: through a broker.
You may have heard the words mortgage lender and mortgage broker used interchangeably, and while a lender can also be a broker, these terms have different meanings. A broker is, essentially, a middleman that connects borrowers with lenders. Brokers can manage many different private and independent lenders at a time, and so they can help borrowers quickly and easily connect with a lender that suits their financial needs.
For the best results, approach a mortgage broker with a good idea of the kind of mortgage you’re looking for, and be honest about your goals and your financial situation. There are many lenders out there who are willing to negotiate to your terms, so be specific.
Are Private Lenders Safe?
While the majority of private lenders are licensed, experienced, and willing to work together to help you pay off a mortgage and own your property, it’s always a good idea to do your research first.
You can apply directly with a private lender, but be aware of predatory lenders, and mortgage plans that seem “too good to be true.” Before agreeing to any mortgage, make sure you understand the terms, and ask questions like:
- What is your interest rate?
- How much are you expected to pay each month?
- Are there penalties for overpaying or missing a payment?
- When can your lender invoke power of sale?
- What contingencies are you prepared to negotiate if you run into financial hardship?
Do Private Lenders Need to be Licensed in Ontario?
It depends on how the lender is doing business. Lenders that are providing mortgages and doing business as independent entities need to be licensed. However, lenders who are working through a licensed brokerage do not need to be licensed — in this case it is assumed that the lender is following rules and regulations that fall under the umbrella of the brokerage’s license.
Always make sure that your chosen lender is properly licensed, and read the fine print carefully before signing any mortgage agreement.