As today’s banks reject riskier real estate investments, an increasing number of borrowers are gravitating toward private lending and other alternate sources of financing. Private lending, offered through private individuals or companies, finances borrowers who don’t qualify for traditional mortgages.
A private loan is often more expensive for the borrower and riskier for the investor. However, private financing can assist borrowers who have damaged credit, are self-employed, or want to purchase unconventional properties, all while expanding investors’ portfolios.
Is a private loan right for me?
Consider private financing if:
- You’re self-employed or lack traditional income. This can include paying yourself salary, dividends or shareholder loans from your own company, reporting income from your business on your personal taxes, or reporting a gross business income that’s higher than your net business income. In any case, a lack of traditional income doesn’t automatically disqualify you from private lenders.
- You’re purchasing a foreclosure, renovation property or a property with structural issues (asbestos, oil tanks). These properties don’t often qualify for traditional financing.
- Your credit doesn’t meet traditional lenders’ standards, perhaps because you’ve experienced identity fraud or you’ve over-extended your unsecured debt. Private lenders don’t automatically disqualify buyers based on credit and a private loan can be an effective way to rebuild your credit rating.
- You own multiple homes, vacation properties or rental investments.
- You want to take more equity from a property than traditional lenders will approve. Banks will lend up to 80% of a property’s appraised value, while private lending can approve more than that amount.
- You’ve experienced a life changing event, like illness, divorce, job loss or a recent move to Canada.
- You want quicker financing with fewer application steps, or you’re looking for more flexibility than traditional lenders can offer.
The price of private lending
Because private lenders take on more risk than traditional lenders, the fees are often higher. As a borrower, you’re often required to cover transactional fees but you may be able to include some of them in the loan.
While rates and fees are decided on a case-by-case basis, you can anticipate:
- Interest rates ranging from 7-10% on a first mortgage, 11-16% on a second mortgage, and higher on a third mortgage.
- Lender fees ranging from 1-2% of the loan amount.
- About $3,000 in legal fees.
- Broker fees, which are either a fixed fee or a percentage of the loan amount.
- Appraisal fees.
Are you a lender? Know the risks.
A borrower defaulting on a loan is the biggest private financing risk. As an investor, the amount of risk you’re willing to take should depend on a number of factors, including the borrower’s finances, credit and their existing properties.
Imagine you’re faced with two comparable investment opportunities. Both borrowers are self-employed and each owns a residential property. One property is in Victoria and the other is in Port Alberni. The borrowers each require a $50,000 second mortgage, a 13% annual interest rate, and will cover any associated closing costs. Each of their existing properties hold a traditional mortgage and your investment will account for 90% on each property. Would you lend against the Victoria or the Port Alberni property?
A private lender needs to evaluate which property will allow them to best mitigate their losses in case of default. As a private lender, you can move toward foreclosure and recoup funds in the property’s priority order (you’ll get paid after the lenders ahead of you receive their funds). The amount that you recoup depends on how long it takes to sell the property and how much is left after the first lenders are paid. Knowing this, an investor should consider each potential property’s market and lend based on which is less risky.
Whether you’re a borrower or a lender, private financing can be a viable alternative to traditional mortgages. A private loan can assist a borrower who doesn’t qualify for traditional financing. While risky, the higher fees associated with a private loan can help an investor strengthen their portfolio.
Want to learn more? Contact me to discuss your private lending needs.
Ofir Varsulker, B.A.
Specializing in alternative lending solutions