Financial experts urge caution amid rise in private mortgages

Once a financial fringe area, a growing number of Canadians are turning to this last-ditch money to dig out of debt. Experts say: beware

Amid a high interest rate environment and a resilient housing market with persistently high prices, many Canadian homeowners are turning to private mortgages to finance their properties.

In Ontario, the proportion of all brokered mortgages taken out through private lenders has grown from 8.4 per cent in 2014 to 11.7 per cent last year, according to data from the Financial Services Regulatory Authority of Ontario (FSRA).

“There has been a tremendous proliferation of these private mortgages,” said Christopher Molder, principal broker at Tridac Mortgages. “It was kind of a fringe area of financing in the mortgage world. In the last eight to 10 years, however, they’ve become much, much more popular.”

But as private mortgages become a go-to option, increasingly offered to those stretched thin by mounting debt, experts warn the risky financing plan is unsuitable for many homeowners, who could be left with a host of unintended consequences and an even larger hole of debt if they choose to take one out.

The Toronto Star spoke with three financial experts and mortgage brokers who explained the differences between a traditional mortgage and one offered by private lenders, along with their benefits, drawbacks and features that consumers should consider.

What are private mortgages and how do they differ from other loans? Canada’s mortgage providers can be grouped

into three categories: A lenders, B lenders and private lenders.

The first group, also known as traditional lenders, is largely comprised of the big banks and credit unions, who typically offer mortgages with the lowest interest rates. As these banks are federally regulated, homeowners looking to take out a mortgage must first pass a stress test — proving they can handle an interest rate of 5.25 per cent or the rate they were approved for by their lender plus two per cent, whichever is higher.

“This market is characterized by lenders who are looking for borrowers that qualify under the criteria, as set out by the regulator,” explained Molder. “As a result, borrowers can expect to get the best interest rates available.”

B lenders, meanwhile, tend to offer mortgages with a lower qualifying benchmark but higher interest rates. These loans, sometimes referred to as subprime mortgages, are usually geared to homeowners who may not have the strongest credit history and don’t qualify for a loan from the traditional lenders. Popular B lenders in Canada include Rocket Mortgage, Citadel Mortgages and Neo Financial.

The final group, private lenders, usually provides mortgages with the lowest qualifying barrier but the highest interest rates. Homeowners who wouldn’t otherwise be approved by A or B lenders can usually access these types of loans.

James Laird, co-CEO of ratehub.ca and president of CanWise Financial, noted private mortgages can run the gamut due to the range of lenders in the sector.

“There really are no rules for private lending other than there being a consumer who needs money and someone willing to provide it,” he said. “As long as those two individuals are in agreement on the terms and conditions, then you’ve got a private mortgage.”

What should you know before signing a private mortgage?

Private mortgages usually have interest rates that are several percentage points above traditional mortgages. They can also carry high fees, totalling anywhere between one to three per cent of the overall mortgage.

On top of all that, most of these private loans are interest-only, meaning payments only go toward the interest, not the principal balance.

Molder describes the arrangement like renting money. “You haven’t paid anything down,” he said. “You’re just maintaining it.”

Because of that, it’s crucial borrowers have a sound “exit strategy” before signing such an agreement, said Ian Calvert, vice president and principal of wealth planning at High View Financial Group.

That could involve a plan for borrowers to improve their financial situation and credit score to a point where they can qualify for a traditional mortgage with lower interest rates.

“Continually renewing a private mortgage is not a cycle that you want to find yourself in over the long term,” added Calvert. “It’s harmful to those borrowing the money, likely preventing them from building up much equity and liquid or retirement assets.”

Why are private mortgages becoming more popular?

The private mortgage industry has ballooned over the past decade. According to the FSRA, the total dollar value of private mortgages in Ontario has nearly tripled between 2014 and 2022, from $9.1 billion to $25.9 billion.

Much of the spike can be attributed to the pandemic and the period of low interest rates, paired with a hot housing market and a desire from many prospective buyers to cash in.

“We had this environment where private money was really cheap,” said Molder.

Now, however, some of those private mortgage holders are struggling. Because many of these loans are renegotiated after 12 months, mortgagors are now staring down eye-watering interest rates that seemed unfathomable several years ago. It isn’t merely the low interest rates from earlier in the pandemic that prompted the rise of private mortgages.

The mortgage stress test, introduced by the federal government in 2016, also caused some people to consider the alternative if they couldn’t qualify for a traditional bank loan.

“The harder it is to qualify for a prime mortgage, we know more people will not be on it,” said Laird.

Who is best suited for a private mortgage?

A private mortgage isn’t for everyone, the three experts underscored. And it shouldn’t be the automatic go-to alternative for those who don’t qualify for a traditional bank mortgage nor for people who are currently renting and looking to buy a house for the first time.

“If you don’t qualify for a prime mortgage, generally speaking, I recommend that you don’t get a mortgage and focus on what would get you in the box for prime,” said Laird. The nightmare scenario for those with a private mortgage and are unable to exit it, said Molder, would be that they’re stuck in a cycle of these loans, with the mortgage increasing at each renewal.

But there’s also a place in the mortgage ecosystem for these types of private loans, noted Laird.

They can be used as a short-term bridge when homeowners are between two properties, for instance, or if they have experienced a financial emergency preventing them from immediately qualifying for a traditional mortgage. They can also act as a stopgap for those who may otherwise default on their loans.

“I do think private lending fills an important gap in lending in Canada,” said Laird. “There’s sometimes a negative connotation around private lending and there can be negative scenarios certainly, but generally speaking, it is important to have that sort of free market.”