A house for sale in the east end of Toronto, on March 22.Cole Burston/The Globe and Mail
In a Canadian landscape of high-interest rates and rich house prices, mortgages from private lenders have become a lifeline for many debt-laden homeowners – and a hazard for some.
Mark Morris, Toronto-based real estate lawyer with LegalClosing.ca, is seeing a steady stream of new clients struggling with borrowing costs.
“There’s blood everywhere.”
Many borrowers are turning to private lenders because higher interest rates and real estate prices have made it difficult to meet the high bar of qualifying for a mortgage with one of the big banks or credit unions. In some cases, homeowners line up a primary mortgage with a traditional lender and add a second mortgage with a private syndicate.
The challenges have intensified along with the Bank of Canada’s rate hiking campaign, which brought its benchmark interest rate to a level of 5 per cent in July. That series of increases raised borrowing costs for homeowners with a variable rate mortgage or home equity line of credit.
People who borrowed against the equity in their homes to gain more spending power no longer have that option if they have stretched their debt levels or the property has fallen in value.
“We have people who are overextending themselves and don’t have the income to match,” says Mr. Morris. “And they can no longer use their house as an ATM.”
Private and alternative lenders account for approximately 10 to 12 per cent of the country’s mortgage market, and that share has been rising in 2023, according to Canada Mortgage and Housing Corp.
Nationally, mortgages in arrears have edged up but remain near historically low levels, according to the crown corporation.
CMHC cautions that homeowners are exhibiting signs of financial strain: the crown corporation’s fall report on the residential mortgage industry shows notable increases in mortgage delinquency at some stages of the process.
Consumers are also increasingly struggling to make their payments on auto loans, credit cards and lines of credit, CMHC notes.
Leah Zlatkin, mortgage broker and expert with LowestRates.ca, cautions that taking out a mortgage with a private lender should always be viewed as a temporary measure.
The lenders, which include mortgage investment corporations, private syndicates and mom and pop investors, tend to charge steeply higher interest rates and fees compared with traditional lenders.
Loans in the private segment aren’t regulated in the same way as mortgages from the traditional A and B lenders are, Ms. Zlatkin points out, adding that borrowers who aren’t aware of the pitfalls can harm their finances in the long run.
As more borrowers have turned to private lending in recent years, Ontario’s Financial Services Regulatory Authority has bolstered the education required for the province’s mortgage agents and brokers and strengthened the guidance they must offer to their clients.
Most importantly, mortgage brokers have a duty to map out an exit strategy, Ms. Zlatkin says.
She adds that there are various reasons why some people are facing challenges today in addition to higher interest rates and inflation.
She points to the example of families who decided during the COVID-19 pandemic that one parent would leave the work force to stay home and look after the children.
Down one income, they are now having trouble renewing an existing mortgage. In that case, they might top up a small conventional mortgage with a second mortgage from a private lender.
That loan should only provide a temporary bridge until the couple’s income ramps up again, she says. Ms. Zlatkin would advise the stay-at-home parent to return to the work force.
“You need to have a plan. If you don’t have that with your broker, go find someone else.”
In another scenario, people who can no longer manage a crushing debt load and need to negotiate a consumer proposal or declare bankruptcy, for example, may decide to consolidate their loans.
Ms. Zlatkin would line up a loan with a one-year term, and then lay out a plan for aggressively paying it off so the client’s credit rating would improve over the course of the year.
“This is just a station they pass through on the train of life.”
A real estate investor with an expanding portfolio may seek out a loan in the private segment. Traditional lenders, she says, often become skittish as investors add more properties.
“People are very inclined to pay to keep a roof over their own heads. They’re less inclined to pay for a roof over someone else’s head.”
Pritesh Parekh, a real estate agent with Century 21 Legacy Ltd., says investors are often more likely to crunch the numbers in the profit and loss columns on their portfolio and weigh those against the higher interest rate they might pay to a private lender.
An investor with a large stable of properties may figure that paying a higher rate will be offset by the potential profit.
In his experience, people buying a home for themselves steer away from those calculations.
“Investors tend to be, on average, more sophisticated on their [profit and loss]. For non-investors, it seems like a more risky path to go down.”
At his law office, Mr. Morris also sees problems arise after parents, grandparents and other family members have co-signed a loan.
If the primary borrower can’t keep up the payments, the co-signer is responsible for paying off the debt.
Huge numbers of people who have purchased a home or refinanced in the past few years have had family involved, he says.
In the past, parents often helped their adult kids with a modest down payment. Now those down payments may be $200,000 or more and the parents are also signing on the mortgage.
“There are generations who have roped themselves in,” he says.
That trend has softened what could have been a harder landing for the housing market, he says, because parents may have chosen not to bail out their children in the past, but today the older generations are on the hook themselves.
Mr. Morris says some borrowers turn to him for help if they can’t pay off the short-term loan in full and the lender takes a hard stance, but many private and alternative lenders are being generous with their existing mortgage base, he says.
Properties have fallen in value in some areas, he says, but some lenders are not even asking for an appraisal at renewal.
“They will allow them to renew as long as they are keeping up their payments,” he says.
Many who bought during the pandemic have a low-interest rate locked in until 2025 or 2026.
He expects to see more distress when those mortgages come up for renewal at higher rates.
Ms. Zlatkin also urges borrowers to understand the loan-to-value ratio so that they don’t become laden with risky debt.
If a house is worth $1-million (a realistic $1-million, she stresses), and the homeowner owes $750,000 on a mortgage loan and $50,000 on a home equity line of credit, that $800,000 represents 80 per cent of value.
“You don’t want to have more than 80 per cent owned by somebody else,” she says. “Buddy, you’re pushing it really close.”
Ms. Zlatkin adds that banks have also become more stringent with LTVs. The previous 80-per-cent threshold has been pushed down to about 65 per cent at traditional lenders, she says.
Some private lenders are lowering maximum LTVs to 70 or 75 per cent as they create a cushion against risk – especially careful in rural areas, she adds.
For buyers and homeowners who do want to pursue a private loan through a mortgage broker, Ms. Zlatkin recommends that they seek out a referral from someone they trust.
Reputable underwriting is important, she stresses. She deals with dozens of private lenders in her business, with many specializing in certain niches, such as cottages in the Kawartha Lakes or micro-condos in Toronto.
She advises borrowers to understand that private lenders tack on fees to the loan, including one that covers the mortgage broker’s commission. With a conventional mortgage, the bank pays the broker’s commission.
There are good reasons to be wary, she adds.
At the height of the pandemic, Ms. Zlatkin worked with a newly-married couple who planned to buy their first house.
Ms. Zlatkin calculated that the pair would qualify to buy a house valued at $1.1-million.
They lined up some family members to co-sign and their budget rose to $1.8-million.
Ms. Zlatkin advised the couple to work out how they would grapple with the monthly payments for the detached house in a new suburb.
The couple decided to back away from the purchase.
Ms. Zlatkin says the interest on a variable-rate mortgage was 2.2 per cent at the time. But by the planned move-in date, the interest rate was hovering around 6.4 per cent.
“They would have lost the house within the first four months of being in the house,” she says.
She uses the cautionary tale to illustrate how people can easily get into trouble if they receive bad advice.
“People in my industry can make a lot of money from private mortgages,” she says. “You have to make sure they have your best interests at heart.”