A private mortgage can provide an alternative financing solution when traditional bank or institutional financing is not currently available. But obtaining the mortgage is only one part of the plan.
Before entering into private financing, it is important to consider a key question:
How will you exit the private mortgage when the term ends?
For many Ontario borrowers, a private mortgage is intended to be a short-term financing solution. Having a realistic exit strategy from the beginning can help you understand the costs, timeline and steps required to transition to your next financing solution.
What Is a Private Mortgage?
A private mortgage is generally funded by an individual investor, mortgage investment corporation (MIC), or other private lender rather than a traditional bank or credit union.
Private lenders often place greater emphasis on the property’s value, available equity and overall risk of the transaction.
Private financing may be considered when a borrower is dealing with circumstances such as:
- Credit challenges
- Income that is difficult to document conventionally
- Self-employment
- Tax arrears or other debts
- A time-sensitive transaction
- A property that does not meet conventional lender guidelines
- A temporary financial setback
- The need for short-term financing while preparing for institutional financing
Private mortgages can provide flexibility, but they can also carry higher borrowing costs than conventional mortgages.
That is why the exit strategy matters.
What Is a Private Mortgage Exit Strategy?
A private mortgage exit strategy is the plan for repaying or replacing the private mortgage at or before maturity.
The appropriate strategy depends on the borrower’s financial circumstances, property, income, credit profile and longer-term objectives.
Ideally, the exit strategy should be considered before the private mortgage is arranged, rather than shortly before maturity.
Common Private Mortgage Exit Strategies
1. Refinance With an A Lender
For some borrowers, the objective is to improve their financial position sufficiently to qualify with a bank or other prime lender.
During the private mortgage term, this might involve:
- Improving credit
- Paying obligations on time
- Reducing unsecured debt
- Establishing more stable or documentable income
- Resolving outstanding tax or credit issues
Qualification will depend on the lender’s requirements at the time of refinancing.
2. Move to an Alternative or B Lender
A borrower who is not yet able to qualify with an A lender may potentially qualify with an alternative lender.
This can sometimes provide an intermediate step between private financing and conventional financing.
Again, qualification depends on the borrower’s circumstances and the lender’s guidelines at that time.
3. Sell the Property
In some situations, the planned exit is the sale of the property.
For example, private financing may provide additional time to prepare a property for sale or complete a transaction without being forced to sell immediately.
If selling is the intended exit strategy, the expected timeline, property value, mortgage balance and selling costs should all be considered.
4. Improve Income Documentation
Self-employed borrowers sometimes use private financing because their current income documentation does not meet institutional lending requirements.
If the business and income become better established during the private mortgage term, refinancing options may improve.
The key is to understand what documentation a future lender is likely to require and work toward that goal during the private term.
5. Use a Known Future Source of Funds
Some borrowers have a clearly identifiable future source of funds that may repay the private mortgage, such as proceeds from another property sale.
The timing and reliability of that source of funds should be carefully evaluated before relying on it as the exit strategy.
Why Waiting Until Maturity Can Be Risky
One common mistake is treating the maturity date as the date to begin thinking about the next mortgage.
By then, the borrower may have limited time to address credit, income documentation, debt levels or other qualification issues.
Instead, the private mortgage should generally be reviewed well before maturity.
If the intended exit is refinancing, an earlier review provides time to determine whether the original plan is still realistic and whether changes are needed.
Understand the Full Cost
Interest rate is only one component of private mortgage financing.
Depending on the transaction, costs can potentially include:
- Lender fees
- Brokerage fees
- Legal fees
- Appraisal costs
- Renewal or extension costs
- Other transaction-related expenses
Before proceeding, borrowers should understand both the mortgage terms and the anticipated costs of entering and eventually exiting the financing.
A Private Mortgage Should Have a Purpose
Private financing can be useful when it solves a specific short-term financing problem and there is a reasonable plan for what comes next.
Before arranging a private mortgage, consider:
Why is private financing needed today?
What needs to change during the mortgage term?
What is the intended exit?
Is the timeline realistic?
These questions can be just as important as the initial approval.
Considering a Private Mortgage in Ontario?
Every situation is different. Before proceeding with private financing, it is important to review the available options, costs, risks and potential exit strategies.
A mortgage professional can help assess whether private financing is appropriate and, where it is, develop a strategy for both entering and exiting the mortgage.
Chi Ying Tammy Lui
Mortgage Agent Level 2 | Ontario
This information is for general educational purposes and is not a commitment to lend. Mortgage approval, rates, fees and terms are subject to lender criteria and individual circumstances.