When to use private lenders

Hello, and welcome to the blog. Let’s look at the three types of lenders in the market and define how they operate. We will discuss when to use private lenders, who they are, and why we need them in real estate investing.

An A Lender is your traditional bank. High street banks require your credit score to be a minimum of 650 or higher and that you have verifiable income from a job that meets strict debt service ratios. Your total debt payment cannot be more than 44%. The debt to service ratio is up to four to five times your income as a rule of thumb. In Ontario, that might be very difficult to do. A Lenders determine salary income. They are not so favorable towards self-employed, AirBnB rent, or just regular rents. Foreign income does not qualify. A Lenders will require you to meet strict criteria that will suit employed people, have a healthy credit score, and provide a sizeable down payment.

The next level of lenders is B Lenders. They require a lower credit score than A Lenders, usually around the 500 plus mark. They will also be more flexible regarding income, recognizing self-employed applications. They require verification of income.

Then we have Private Lenders. They focus on the property’s collateral and equity but require you to present a business plan. Reasons include self-employed contractors requiring a small loan secured on their business. Another reason is for tax purposes so that you can write off payments as business-related expenses.

So if you are self-employed and want to qualify for a loan to purchase or invest in a new property, you will need to work with a mortgage broker and a wealth adviser to help you draw up a business plan as soon as you can. If you know you are applying for a mortgage at a future date,  you need to get started well in advance as you require at least two years of verifiable income. Deductible expenses can be factored in to show more income to qualify for a larger mortgage. The same applies to real estate investors. Mortgage companies, A and B lenders, are becoming very strict towards investment properties, even if they are cash flowing. They are reluctant to finance investment properties as they see it as a risk, especially if your cash flow is tight or non-existent.

I always advise people to perform a business analysis of your property and determine if you are in a position to carry any negative cash flow. In Ontario, Canada, I know it is difficult to find a cash flowing property. Therefore property investors use private funds, as it’s easier to qualify, especially if you have more than one property. Suppose you own your home and have a minimum of 20% equity. In that case, you may be able to consolidate other debts, as private lenders have lower interest rates than credit cards, So this could be in your best interest, and you may be able to lower your monthly payments.

The following reason includes people new to Canada, who may have funds and are ready to buy property but don’t have a credit rating which is the same as having a poor credit rating, so they have to wait. Therefore a private lender is ideal for them. If they have the down payment and can show verifiable income, then they can do it for a short time. Another reason to use private lenders is for bridging loans designed to finance a second property while you are waiting for the sale of your primary property. Another reason you may want to use a private lender is for a life event such as an unexpected illness, a loss of your job, a divorce, or you want just to pursue further education.

One of the questions I get asked is if dealing with private lenders is it safe to go through a mortgage broker in order to get access to private lenders, as the Financial Services Commission of Ontario also regulates private lenders. The answer is that it is safe, but you need to ensure that you access them through a mortgage broker. There are three factors that private lenders look for when evaluating your loan application, and one of them is the location of the property. The second is the down payment size, and the third is your overall financial health. So let’s look at each one individually. The location of the property is the most crucial factor. Lenders may be lenient about your credit and income, but they want to make sure that they can secure the property asset as collateral if something happens. So the better the location of your property, the higher the chances of approval. The second factor is the down payment; most private lenders will approve if you have 15 to 20%, and if you have more, it would be better for a lower interest rate.

From a business plan perspective, the most important thing you need is to have an exit strategy to show the lenders what are you planning to do with the loan.  You are requesting a private mortgage as you need to establish your credit rating. You need to show the lender your plan as private lenders will still consider your income, your credit score, and any investments that you have. With this detailed and professionally organized financial information, the chances of loan approval are better.  

One of the positive aspects of private lenders is loan approval speed. But this will require all the documentation to be in order before they approve your loan. You will also require two forms a photo ID and the purchase and sale agreement from the property. If refinancing, you need your tax accounts and your mortgage statement. If you have all these documents, you can be approved within two to three days. One thing you need to be aware of with private lenders is that they are more expensive, or they will charge you higher interest than a bank or B lenders.

With private lenders, you can also have an open or a closed mortgage depending on your personal circumstances and how long you’ll be keeping that mortgage. One positive feature about prepaid mortgages is that if you’re looking to not have payments for the period you have the mortgage, you can have the interest and fees charged up front. So if you are applying for a one-year private mortgage of $100,000 at 7.99 with a 2% fee, you will need to pay $2,000 to the lender fee at closing and your total interest for the year will be $7,990. So when you choose to prepay your mortgage, the lender will take the $9,990 which is the $7,990 plus $2,000, from the mortgage’s principal, and they’re going to give you only the difference; in this case, it would be $90,010. So that is a really good feature if you’re looking to invest in a fix and flip property as you don’t have to worry about paying the mortgage payments. However, if you don’t, they will renew the entire mortgage at $100,000 for another year. So you just have to be careful with that. So I hope this clarified what a private lender is.

Remember, you always have to go through A lenders, primarily banks or B lenders, smaller banks or credit unions. If none of them works for you, a private lender maybe your best option. Private lenders require fewer qualifications for loan approval. The most crucial part for private lenders is the location and the amount of down payment which is a minimum of 15 to 20%. A business plan is then required, as is your overall financial position. So that’s what they want to see, an excellent strategic plan written professionally. If you would like to have more information on how to start investing in real estate, please visit my website at www aracelihernandez.com Thank you

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