Private mortgages have become more common than you might expect in recent years. While they’re still much rarer than the traditional route, there has been a significant uptick in private mortgages in Ontario in just the two-year span from 2019 to 2021. According to the Financial Services Regulatory Authority of Ontario (FSRA), the rate of private mortgages increased by a whopping 72 per cent in that time.
What is a private mortgage anyway?
According to Ivan Lobo, a real estate consultant at Made in CA, a private mortgage is “a flexible option for borrowers who may not qualify for a conventional mortgage, because of poor credit or other financial situations.” When someone doesn’t qualify for a conventional mortgage, they might decide to take out a private mortgage instead, so they can still make the offer on the home.
“Private lenders don’t require borrowers to undergo stress tests, which banks use to ensure that buyers can afford a mortgage rate that is two per cent above the current rate,” Lobo says. “This exemption offers borrowers more flexibility if they don’t meet the strict underwriting standards of banks.”
Basically, a private mortgage avoids the stress test, so you can qualify for a private mortgage easily. They also have shorter terms than the traditional five-year term that you would receive from a bank, at just one or two years.
Is there a higher default risk?
Since private mortgages lack oversight and regulation, this can create a significant risk for borrowers. “Private lenders usually charge higher interest rates and additional fees, leading to higher costs for the borrower over the loan’s life,” says Lobo. These costs “could cause defaults among borrowers who have overextended themselves.”
Because the loans are short term at only one or two years, they also require renewal more often. And those with a private mortgage at a high interest rate may not even be able to renew their loan at all. “For markets where house prices have fallen say 30 per cent or more, it’s very likely for private lenders to call in the loans,” Lobo said.
And if the borrower is able to renew, the rate will likely end up much higher than the initial offer, leading to a significant default risk.
What does this mean for the market?
If default rates rise, this can have a negative affect the market. According to the Canadian Bankers Association, the default rate for November 2022 was at 0.07 per cent. If that number starts to rise in a significant way, it will inevitably affect the market as power of sales start to pop up with regularity.
Currently, the default rate isn’t concerning, but reports on the rate lag by months.
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