Private lending a growing option
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07/07/2010 10:43:00 PM
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At the end of 2008 and beginning of 2009, the appetite for private lending was strong, but the uncertainty of the economy and the housing market meant that finding a private mortgage was often a daunting challenge.
While there are still complexities in putting together a private deal and finding financing, getting private funds has become considerably easier now that the housing market has rebounded and property prices in many Canadian cities are soaring.
“We scaled back funding a lot at the end of 2008, but by the spring of 2009 we started to see an improvement and we have been increasing our LTVs since then,” says Dougal Shewan of V.W.R. Capital Corp., a private lender based in B.C. that offers up to 75 per cent LTV mortgages.
Steve Gilmour, a Dominion Lending Centres broker who specializes in private lending, has also seen the tide turn.
“Private lenders are back in full force right now and there isn’t a province that isn’t covered,” says Gilmour, who gets most of his referrals from collection agencies.
The fact that many private players are more willing to lend is good news for categories of borrowers like real estate investors and business-for-self clients who are affected by the new mortgage insurance rules implemented by the federal government and the CMHC, as well as those looking for commercial or construction funding.
The availability of private funds also presents new opportunities for mortgage brokers who want to get their feet wet in this area of mortgages.
Explaining private mortgages
Private mortgage lenders operate differently from banks and other mortgage lenders on many levels. One of the major differences is their source of funding – private lenders get their money through individual investors or groups of investors. Some of these lenders pool mortgages into a MIC (mortgage investment corporation) while smaller investors might simply lend out their own money. In both cases, the private mortgage is seen as a short-term investment that can be sold off within a year or two as opposed to something to keep on a balance sheet.
“Private mortgages fill the gaps that institutional lenders like banks are unable or unwilling to fill,” says Omid Jalili of OMJ Mortgage Capital, a brokerage that focuses on private lending such as commercial and construction loans. “They offer an alternative source of financing to borrowers and a high-yield investment opportunity for investors.”
Private money can cover anything from first mortgages and, more commonly, second and third mortgages that are harder to obtain from institutional lenders. It is also commonly used for construction and commercial financing, which banks are hesitant to touch.
“In residential deals, private funds generally come into play for clients with tarnished credit, lack of income verification or those who want a quicker closing,” says Jalili. “On the commercial and construction side, private funds are primarily used to reach higher LTV ratios. For example, with construction financing, clients are often able to obtain 100 per cent of the hard costs, which is not even remotely possible in the world of traditional lending.”
Another difference between bank mortgages and private mortgages is the application process. Instead of the borrower being scrutinized, the property is what gets the most attention from a private lender. This is because private loans are uninsured, meaning the lender must fall back on the property should a default occur. For this reason, properties in smaller towns or rural areas likely won’t qualify for as much money with a private lender – 65 per cent LTV compared to 85 per cent in an urban centre, for example.
“Our primary criteria is the condition the property is in, where it’s located and how easy it is to sell if the borrower gets into trouble. If that fits, we look at the character of the client, their ability to repay, and the purpose of funds,” says Chuck McKitrick, president of the private lending company Alta West. He adds his company doesn’t often verify borrower income, which can be attractive to many real estate investors or self-employed clients.
On the client side, the main differences between private mortgages and institutional mortgages are higher pricing (see sidebar), shorter terms (usually between six and 18 months) and, in many cases, a shorter closing time.
Putting together a private deal
Many brokers who work in the area of private lending recommend co-brokering a few private deals before entering that niche of the market. This is because it can take time to build trust with private lenders and investors and understand the differences between private deals and institutional deals. It’s also important to note that all private lenders have different requirements, rates, fees and standards.
Gilmour says he has three rules when putting together private deals. One, he never goes above 75 per cent LTV. Two, he doesn’t charge “ridiculous” fees (only up to five per cent of the loan). And three, he makes sure the client has an exit strategy.
“You really don’t want the person to be in a situation they can’t get out of,” says Gilmour. “You want the private money flowing back and forth quickly.”
To prevent power of sales or other tricky situations for the private lenders he works with, Gilmour says he treats these types of deals very similar to A deals, including asking clients for all the same documents – credit bureau, employment information, etc. – to find out the story behind why the client needs private money.
If a client has no sign of credit history or a job, Gilmour says he is “hard-pressed” to touch their file.
“Private lenders still want to know what the mortgage is for and the client’s ability to pay, so there is a lot of due diligence done to protect them,” says Gilmour. “My private lender sees the full package – it’s the same as something I would send to a bank. That way if the deal does fall apart, they’re not coming back to me with questions – they have a full package of disclosure upfront.
Dougal Shewan, president of the private lender V.W.R. Capital Corp., agrees that even though private lenders are more lenient than institutional lenders when it comes to credit scores, repayment history and employment, his company does look at a client’s serviceability and the purpose of the loan because they don’t want clients who are in over their heads.
“Sometimes people are just financing their house away and you don’t like to see that happen – and from a moral point of view, you want to say to the client they should be selling their house and getting their debts under control,” says Shewan, whose company lends in B.C. and Alberta, with plans to expand to Manitoba in the near future.
Fortunately, he adds, most clients he sees have a reasonable purpose for borrowing private funds – in other words, not using the money to finance an out-of-reach lifestyle. And while most clients who need private financing understand the higher interest rates and fees involved, Shewan says brokers need to manage client expectations when someone is getting a private mortgage for the first time.
“These clients need to realize that they’re not A borrowers and they’re not going to get A rates – that conversation needs to be had right upfront.”
Private money uses
Two categories of borrowers recently affected by new mortgage insurance rules are real estate investors and business-for-self borrowers.
The one new federal mortgage insurance rule real estate investors have become very familiar with is the requirement of a 20 per cent down payment for non-owner-occupied investment property purchases.
“Not everyone can come up with a 20 per cent down payment, so one of the options is private money,” says Carmen Capagnaro, an Oakville, Ont.-based mortgage broker with RMAI. “Anyone who is buying in that smaller category has the ability to get up to 90 per cent financing with private funds as opposed to 80 per cent with a traditional lender.”
Aside from help with down payments, real estate investors turn to private lenders for a variety of other reasons.
A common scenario McKitrick sees is an investor who does “fix and flips” and only needs money for a short period of time before re-selling a property. Another instance is when the investor wants to buy a distressed property – a foreclosure, for example – and fix it up. Because banks often won’t touch these types of properties, an investor can buy with private funds and once the property is fixed and producing a cash flow, they can access cheaper funds from an institutional lender.
“For the investor, we’re often seen as that short-term solution – we’re a stop-gap,” McKitrick says.
Property investors might also find themselves in a situation where their investment property is not bringing in the current market value of rent and may need time to renegotiate leases or complete renovations that will allow them to charge tenants higher rents. In this case, they could take out a second mortgage with a private lender and once the issue is solved, they could find more conventional financing elsewhere.
Another category of borrower that private lenders can help are business-for-self clients, particularly after the CMHC-implemented new rules that make it harder for these borrowers to get a mortgage. Sherwen says he sees a lot of private mortgage applications from self-employed borrowers, particularly if they need a higher ratio mortgage than the bank will provide. Private lenders can also do “top ups” if, for example, a bank gives a borrower a 65 per cent LTV mortgage and they need another 20 per cent to purchase a property.
Whatever case your client presents to you – be it a BFS client who needs a first mortgage or a more complex commercial deal that needs a patchwork of financing – knowing that private money is an option is helpful and a stronger market means more of these funds are available if a broker takes the time to find them. And understanding a private loan’s purpose as a short-term solution can make the extra costs easier to swallow for a client – especially if it means they can acquire a great property that might have been out of reach without the help of a non-institutional lender’s funds.
The cost of private lending
Although private mortgages can help borrowers get out of sticky situations or find financing for unique projects, there are additional costs to consider.
First up is the higher interest rate, which can range from a couple of percentage points above a bank loan to upwards of 20 per cent. Lenders weigh the interest rate based on the loan to value needed, the property location and the overall risk factor of the loan.
Other costs borrowers have to be aware of with a private mortgage are lender fees, mortgage broker fees, legal fees and an appraisal if a recent one isn’t available.
“Typically, private lenders charge a fee of two per cent of the loan, but I’ve seen in some cases if the loan is under $50,000, the lender fees go up five per cent,” says broker Carmen Campagnaro, adding the general rule is the higher the LTV on a private mortgage, the higher the fee.
Mortgage broker fees will generally be similar to the lender fee, and often times there are also additional charges for pulling out of a private mortgage early, although terms generally don’t exceed a year –something a broker should check with the lender.
For legal fees, borrowers usually have to pay for both their own lawyer and the lender’s lawyer, which can add another couple of thousand dollars to the tab. While in some cases a lender can roll these fees into the mortgage, others might not be so accommodating, so be sure to check beforehand for your client. Also make sure to ask about the fees if you’re not sure about them – it’s a lender’s obligation to disclose all the costs associated with a mortgage before you take one out.
An overview of four private lenders in Canada
FISGARD CAPITAL CORPORATION
Interest rates: Rates start at 5.99 per cent
Maximum LTV: 75 per cent
Terms: Two-year maximum
Minimum loan amount: No minimum
Maximum loan amount: $5,000,000 (note: depends on the deal presented and borrower’s history with Fisgard)
Provinces served: B.C., Alberta, Saskatchewan, Manitoba
Market focus: Single-family residential properties, owner-occupied or investment properties including multi-family and apartment buildings , single-family construction and income-producing commercial properties
Fees: One to three per cent of the loan value
ALTA WEST MORTGAGE
Interest rates: Seven to 18 per cent
Maximum LTV: 85 per cent
Terms: One year, interest-only payments or 25 year amortizations
Minimum loan amount: $10,000
Maximum loan amount: $2,500,000
Provinces served: Alberta and B.C.
Market focus: Owner-occupied, single-family residential and investment properties
Fees: Three per cent to six per cent of the loan value, depending on risk factors and loan size
THE MONEY SOURCE
Interest rates: 12 to 16 per cent
Maximum LTV: 85 per cent
Terms: One and two year, blended or interest-only payments
Minimum loan amount: $10,000
Maximum loan amount: $250,000
Provinces served: Ontario (the GTA)
Market preference: Owner-occupied residential properties and rentals
Fees: Two to five per cent of the loan value
CAPITAL DIRECT LENDING
Interest rates: 5.50 to 20 per cent (first, second and third mortgages)
Maximum LTV: 80 per cent
Terms: One year (can be longer with rate increase)
Minimum loan amount: $10,000
Maximum loan amount: $1,500,000
Provinces served: B.C., Alberta, Ontario, Nova Scotia, New Brunswick, P.E.I.
Market focus: All residential
Fees: 2.5 per cent and up