Ever since the introduction of the stricter mortgage stresstest, many Canadians have struggled to get traditional financing when buying ahome or getting a second mortgage. As a result, more and more are turning to privatemortgage lenders, which nearly always come at a much higher interest rate.
Private mortgage lenders in Canada can be anything from alarge corporation with hundreds of employees to a single investor, but mostoperate in the same way. They don’t have as stringent requirements for a mortgageas banks do because they don’t have to give the stress test. Unlike banks,private mortgage lenders aren’t federally regulated.
That doesn’t mean privatemortgage lenders in Canada are all loan sharks. They’re just able to getaround this particular law because they don’t take deposits (the reason thatbanks are so closely regulated). They lend with entirely their own, or theirinvestors’, funds.
But while they’re not loan sharks, private mortgage interestlenders rates are substantially higher than bank rates. The best 5-year fixedrate for a new purchase right now is 2.64%, while private lender rates start at7% and can go up as high as 15% for a 2nd mortgage.
The problem with privatemortgage lenders isn’t that they have higher interest rates than banks,it’s that so many homebuyers and homeowners are turning to them to get amortgage in the first place. Since so many Canadians don’t qualify for atraditional mortgage under the new stress test rules, private mortgage lendersare their only option. It’s bad for borrowers, who now have to pay more ininterest charges for what’s essentially the same mortgage.
This change also affects those already with mortgages to a lesser extent. Under the new rules, youhave to requalify for a mortgage at every renewal as well as when you firstpurchase a home, unless you’re renewing with the same lender. This puts a lotof power in the hand of your current mortgage holder, since it’s a lot harderfor you to shop around and find the best rate when there’s no guarantee you canpass the stress test.
It also makes it harder to do something as simple asrefinance your mortgage, even with lots of equity. On average, the stress testreduces your affordability by 20%, even for those who already own their home.
Private lenders get around these regulations, so approval iseasier, but you end up paying for that ease of access. Private mortgages arebest taken for short-term goals, such as covering a temporary cash shortfall orstopping power of sale, before switching to a bank or monoline lender after thesituation is resolved.
While Toronto isn’t different from the rest of Canada whenit comes to the law, it is fairly unique in the Canadian real estate marketbecause of its high housing prices. More people are turning to private lendersin the Toronto and Vancouver area than anywhere else, even among first timehomebuyers, because of the difficulty of overcoming the stress test when prices are sohigh.
The good news is that private mortgage lenders in Torontoare much more lenient than in other areas because of the desirability ofproperties. Private lenders know that even if the borrower is unable to maketheir payments, they will probably be able to get all their money back byselling the property quickly.
Because of the highly desirable market, private mortgage lenders rates in Toronto can often be lower than asimilar private mortgage in other markets. Interest rates go up when the riskof losing money is higher, so the hotter the market, the better for borrowers.