Ever since the introduction of the stricter mortgage stress test, many Canadians have struggled to get traditional financing when buying a home or getting a second mortgage. As a result, more and more are turning to private mortgage lenders, which nearly always come at a much higher interest rate.
Private mortgage lenders in Canada can be anything from a large corporation with hundreds of employees to a single investor, but most operate in the same way. They don’t have as stringent requirements for a mortgage as 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 private mortgage lenders in Canada are all loan sharks. They’re just able to get around this particular law because they don’t take deposits (the reason that banks are so closely regulated). They lend with entirely their own, or their investors’, funds.
But while they’re not loan sharks, private mortgage interest lenders rates are substantially higher than bank rates. The best 5-year fixed rate for a new purchase right now is 2.64%, while private lender rates start at 7% and can go up as high as 15% for a 2nd mortgage.
The problem with private mortgage 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 a mortgage in the first place. Since so many Canadians don’t qualify for a traditional mortgage under the new stress test rules, private mortgage lenders are their only option. It’s bad for borrowers, who now have to pay more in interest charges for what’s essentially the same mortgage.
This change also affects those already with mortgages to a lesser extent. Under the new rules, you have to requalify for a mortgage at every renewal as well as when you first purchase a home, unless you’re renewing with the same lender. This puts a lot of power in the hand of your current mortgage holder, since it’s a lot harder for you to shop around and find the best rate when there’s no guarantee you can pass the stress test.
It also makes it harder to do something as simple as refinance your mortgage, even with lots of equity. On average, the stress test reduces your affordability by 20%, even for those who already own their home.
Private lenders get around these regulations, so approval is easier, but you end up paying for that ease of access. Private mortgages are best taken for short-term goals, such as covering a temporary cash shortfall or stopping power of sale, before switching to a bank or monoline lender after the situation is resolved.
While Toronto isn’t different from the rest of Canada when it comes to the law, it is fairly unique in the Canadian real estate market because of its high housing prices. More people are turning to private lenders in the Toronto and Vancouver area than anywhere else, even among first time homebuyers, because of the difficulty of overcoming the stress test when prices are so high.
The good news is that private mortgage lenders in Toronto are much more lenient than in other areas because of the desirability of properties. Private lenders know that even if the borrower is unable to make their payments, they will probably be able to get all their money back by selling the property quickly.
Because of the highly desirable market, private mortgage lenders rates in Toronto can often be lower than a similar private mortgage in other markets. Interest rates go up when the risk of losing money is higher, so the hotter the market, the better for borrowers.