There has been an upsurge in private real estate funding in the past couple of years due to the increased amount of investment purchases in new condo projects. These projects tend to ask for a larger down payment, and banks tend to be wary of lending the 20% that is required for non owner-occupied investment properties. Another reason for seeking private funding could be the CMHC requirement that borrowers provide traditional proof of income (third party validation) before qualifying for a loan, putting the self-employed at a disadvantage. As a result, many investors are turning to private lenders; alternate sources of funding that provide cash quicker and easier, but with a higher cost in interest rates.
How exactly does it work?
The source of funding for private lenders is through individual investors or group investors. Some lenders have a pool of mortgage funds called a MIC (mortgage investment corporation), while others use their own personal funds. In both cases, the private mortgage is a short-term investment that can be sold off within a year or two. Whilst traditional banks scrutinize the lender (credit checks, equity checks, etc), private lenders scrutinize the property to determine whether they will be able to fall back on it should the borrower fail on his/her payments. For this reason, units in suburban areas, small towns or rural areas are unlikely to qualify for a private mortgage.
The Pros of Private Funding:
- Private funding can come in handy for second mortgages, which most banks do not grant funding for.
- It can be useful for investors that have a ‘fix-and-flip’ approach– completely renovating a unit and selling it for much more than its purchase price. In this case, the interest costs are outweighed by the profitability of the flip.
- Private funding is one of the only ways to buy a foreclosed/distressed property.
- It’s a solution for cases in which an investor has too many units in his/her portfolio to approach a traditional bank.
- Interest rates are a few percentage points higher than a bank loan. In fact they can reach up to 20% higher. Lenders determine interest rate based on the loan-to-value ratio, which takes into consideration the location, quality and marketability of the unit.
- Many lenders also charge a lending fee, which can be up to 2% of the loan.
- There are additional charges for pulling out of a loan prematurely (although terms are rarely longer than a year).
- There are lawyer fees to take into account- borrowers need to pay for both their own lawyer and the lender’s lawyer, which can add another couple of thousand dollars onto the tab. It’s the lender’s obligation to disclose all associated costs before a mortgage is taken out, so be sure to ask for clarifications and to look into these additional fees carefully before committing to anything.