First of all, what is a private mortgage? Well, private mortgages are no different than standard (bank) mortgages with the exception that the lender is usually an individual, a group of individuals or a private Corporation. Similar to a standard or institutional mortgage, a private mortgage is secured and registered against the title to your property. Private Mortgages are not federally regulated, providing more autonomy to the lender with respect to their fees and terms of the mortgage.
While private mortgages have existed as long as, or arguably longer, than standard bank mortgages, those seeking out private borrowing options tend to be self-employed individuals, people with bad credit history or no credit history, and people whose employment income may be unstable and/or unreliable. This is because the qualification requirements for a private mortgage are generally much lower than that of a bank mortgage. However, one requirement of all private mortgages is for the borrower to own a home under their name with sufficient equity remaining in the property to secure the debt. This is to ensure that in the event of non-payment of the mortgage, the lender has the privilege to conduct a power of sale to recoup their initial loan amount and any additional costs incurred. This is the reason why the approval process for private mortgages is generally more property-focused, rather than income-focused.
If private mortgages are easier to apply and obtain, then why does everyone prefer to obtain standard bank mortgages? There are many reasons, but the two primary reasons are: (a) cost; and (b) stability.
Lenders for private mortgages agree to significantly higher risks by lending money to borrowers with bad or no credit, with unstable or no income at all. The probability and likelihood of the borrower defaulting on the loan is much higher compared to a standard mortgage. To offset these increased risks, costs associated with a private mortgage are significantly higher at every stage of the transaction.
Typically, the costs associated in obtaining a private mortgage, such as lender fees and mortgage broker fees are much higher with private mortgages. Lender fees & broker fees are usually charged as a percentage % of the principal amount borrowed, rather than a fixed amount, which is common with bank mortgages. It is not uncommon for lender fees & broker fees to increase to tens of thousands of dollars for a private mortgage.
Private mortgages also have significantly higher interest rates compared to bank mortgages, sometimes even double the bank’s rate. The interest payments may be prepaid and deducted from the mortgage advance. The mortgage payments may also be interest-only, resulting in the principal amount of the mortgage remaining the same (and not reducing) over the term of the mortgage.
There can also be many miscellaneous fees charged by a private lender and deducted from the mortgage funds advanced on closing. These miscellaneous fees are usually labelled as Investor Fee/Bonus and/or Consulting Fee and they are provided for, albeit hidden within the terms, in the mortgage commitment initially signed and accepted by the borrower. I recently completed a private mortgage for which all of the fees, including the broker fee, lender fee, and miscellaneous fees, amounted to nearly $100,000 for a private mortgage under $500,000.
In a standard bank mortgage transaction, the lawyer acting for the borrower also represents the lender. However, the Law Society of Ontario prohibits lawyers from acting for both borrowers and lenders in a private mortgage exceeding $75,000. This can mean that the borrow may also incur additional legal fees for the lender to have separate counsel. The legal fees for a private mortgage, for both the borrower and the lender, are also higher because the liability assumed and legal work necessary to complete the transaction is significantly more comprehensive compared to a standard bank mortgage.
Due to increasing incidents of fraudulent private mortgages, all title insurance companies across Ontario have more stringent requirements to provide coverage and issue a title insurance policy. Therefore, title insurance premiums are also slightly higher for private mortgages due to the increased risk of liability on the part of the title insurance company.
The term granted on a private mortgage is also typically shorter; often only six months and no more than one year, forcing the borrower to have to repeat the process (by securing a new mortgage) and incur significant fees once again.
Similar to the fees incurred on the advancement of the mortgage funds on closing, the fees charged upon the payout of a private mortgage are also significantly higher. It is not uncommon for a borrower to be charged more than the standard three-month penalty, administration fee, discharge fee, statement fee, etc. if they wish to payout the mortgage before the end of the term. The lender will also incur legal fees to discharge their mortgage, which are often charged to the borrower.
Private mortgages are usually a last-resort and, while necessary, can lead borrowers through a vicious cycle of endless of fees, worsening the borrower’s financial position in the end. If you are contemplating borrowing from a private lender, we strongly encourage you to have qualified legal counsel review any proposed commitment letter to ensure that you know what you are getting into.
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This WARDS LAWYERS PC publication is for general information only. It is not legal advice, nor is it intended to be. Specific or more information may be necessary before advice could be provided for your particular circumstances.
