Mark Twain once wrote “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.”
Unless you’ve been in a difficult financial situation you can’t appreciate just how right Mr.Twain is. Trying to talk to your banker or mortgage broker when life throws you a curve ball can be frustrating and outright demeaning.
The 4 most common reasons why a borrower might need a private mortgage.
#1 Debt consolidation & credit rehabilitation
There is no shortage of reasons why you might have taken on more debt that you can't manage.
Health issues, relationship stress, business failure, consumerism, bad financial advice… all reasons why you might have stretched your credit cards and lines of credit to the limit.
If you’re lucky you’ll be able to consolidate the debt into your existing first mortgage through your bank or “A” lender.
However if you don’t meet the minimum lending requirements and have missed payments on your debt, you can find yourself in trouble.
Debt has an amazing ability to snowball especially if you can’t get help from your bank/institutional mortgage lender. Without an option to consolidate you’ll find yourself with growing debt loads which effect your credit score.
This is where a private second (2nd) mortgage lender or private home equity lender come in handy.
Most private home equity lenders will go up to 75-80% of the market value as determined by an appraisal. This is a rule of thumb and depends on need, location and exit strategy.
With the money made available by the private home equity mortgage lender you’re able to consolidate your debt at a lower interest rate into one payment that is hopefully more manageable.
The purpose of the loan isn’t just to improve cash flow. There needs to be a very clearly defined exit strategy.
In the case of debt consolidation the exit strategy is to pay debts off to improve overall credit score over a 12 month period. With new and improved credit you should be able to approach your first mortgage lender to consolidate into a first mortgage so that life can go on.
The biggest risk of using a private home equity mortgage or 2nd mortgage for debt consolidation is if your score doesn’t improve or you can’t consolidate with your first. In that case you’ll be stuck perpetually with high interest mortgage that can be detrimental to your financial well-being.
If you proceed with a private second or home equity mortgage to consolidate debt you’ll want to make sure that you qualify for the eventual “take-out” mortgage required at the end to consolidate both your mortgages together.
#2 Property or income tax arrears
Tax arrears can be a real issue for homeowners. The smallest arrears can present a major hurdle for most A or institutional mortgage lenders.
Income tax arrears and/or property tax arrears cannot be financed by most institutional mortgage lenders. It’s generally considered an extremely important indicator of credit worthiness if a borrower has any kind of tax arrears. Your obligation to pay income tax and property tax is the most fundamental responsibility of a borrower.
There is an added risk to the lender if there are tax arrears because Canada Revenue Agency and your local municipality can take legal action to sell a house to recover their arrears. In this case the arrears actually take first position form the mortgage lender diminishing their security position.
A private home equity or second mortgage can provide the liquidity you need to pay your arrears.
After funding the private mortgage you’ll have the ability to pay your arrears. With proof in hand that you’ve made payment you can then return to your 1st mortgage lender to refinance.
Ironically a first mortgage lender can’t refinance to payoff tax arrears however they can refinance to payoff a private home equity or 2nd mortgage. So it’s kind of a two step dance that needs to be done to present your application for the final approval with your A lender so that you can move forward with more conventional financing.
#3 Stop power of sale
To be under power of sale means that home owners have broken the covenant of their mortgage lender(s) and legal proceeding have commenced to recover money owed to the lender via court ordered sale of the property.
This is a terrible and sad situation typically accompanied with a story of struggle. We’ve observed that home owners generally want to do right by their obligation.
A private home equity loan or 2nd mortgage can help to stop a power of sale and give dignity to the home owner to sell on their own terms and timeline.
The financing provided can be used to pay any arrears and legal costs to bring the 1st mortgage into good standing and also provide extra cash flow for living expense and/or home improvement until the property is listed and sold.
The benefit for a homeowner to employ a private home equity or second mortgage is that it allows them to protect the equity they’ve built up in their home. If sold under power of sale a mortgage lender can add any number of sundry charges for legal and admin work eating up huge chunks of equity.
#4 Bridge loan / financing
The need for a bridge loan comes from timing issues. The need for bridge financing typically arises out of need for funds outpacing availability of funds. The most common example is when a home is purchased prior to a home being sold. In this case, money for a down payment is tied up until a home is sold.
Banks and institutional lenders all provide bridge financing however there is one critical condition. There has to be a firm sale on the property you’re selling. That can be a little tricky at times if the market doesn’t co-operate or if personal circumstances prevent the sale.
A private home equity loan is the perfect solution if you find yourself in this situation.
The private lender can typically provide a loan collateralized against both of your properties to provide the required liquidity.
In addition to real estate closings, bridge loans may arise out of business needs or need to pay family etc prior to you being liquid with cash.
The key feature of a bridge loan is that as a borrower your exit strategy is cash that will be made available on a short term basis.