A dramatic increase in the number of homeowners relying on private mortgages to finance their homes is causing concern in Ontario’s mortgage industry, and the province’s financial regulator says it expects reliance on such high-interest loans to increase.
The Financial Services Regulatory Authority of Ontario said 10.6 per cent of homeowners arranging financing through licensed brokers used private mortgages in 2021, and that number is expected to rise for 2022 and 2023 as high interest rates put further pressure on homeowners.
The dollar value of private mortgages brokered by FSRA-licensed brokers in Ontario increased by 72 per cent between 2019 and 2021, jumping from $13-billion to $22.4-billion.
Private mortgages are generally a short-term financing product for people who are struggling to qualify for traditional mortgages because their income-to-debt ratio is not sufficient, their credit rating is too low, or for other scenarios that banks and other lenders may find too risky. They are often offered by smaller companies and non-traditional lenders, and involve higher lending fees, more restrictions and sometimes payments that only cover interest and don’t chip away at principal debt.
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Ron Butler, a mortgage broker with Butler Mortgage, said the high number of private mortgages in 2021 was driven by a frenzied pandemic housing market, in which buyers disregarded the prices they qualified for and bid hundreds of thousands of dollars outside their budget. He said most bids were unconditional, meaning buyers were scrambling to close and were forced to use private mortgages.
He called the intense growth of private mortgages “a tragedy,” because buyers feel pressure to use these riskier loans both when demand is high and they bid outside their budget, and also when demand is low but increasing interest rates make payments unaffordable.
FSRA and multiple mortgage brokers say the mortgage stress test implemented by the federal Office of the Superintendent of Financial Institutions, which requires borrowers to qualify for higher rates in case interest rates increase, likely pushed more people to private mortgages in previous years (the current stress test rate set in 2021 is either 5.25 per cent or 2 per cent higher than your contracted rate, whichever is higher). They say the pandemic housing environment, where high demand was followed by rapid interest rate increases, likely will lead to more reliance on private mortgages in coming years.
Antoinette Leung, FSRA’s head of financial institutions and mortgage brokerage conduct and market conduct, said her organization’s concern is whether consumers are turning to private mortgages for the wrong reasons or without adequate understanding of the implications.
“Most of the time private mortgages are intended to be a short-term measure that buys time for consumers to get their finances back in order so they can qualify for traditional mortgages,” said Ms. Leung, who said people need to understand why they didn’t qualify for traditional mortgages and have an exit plan.
Frances Hinojosa, co-founder and mortgage broker at Tribe Financial Group in Burlington, Ont., said she’s concerned the rise in private mortgages means that people are getting too comfortable with them and may be looking at them as a permanent financing solution.
She added the Canadian government is currently assessing changes to the stress test program, and any tightening around mortgage qualifications could lead to even more reliance on private mortgages.
“If they tighten it even more, you can’t stop the debt that already exists out there for consumers, and if they can’t qualify at a major institution, they might be put into a position where the only choice is private lending at that point,” Ms. Hinojosa said.
David Larock, president and mortgage broker with Integrated Mortgage Planners in Toronto, says there are some situations where getting a private mortgage is a sensible solution. One example is if someone with a great credit score and finances buys a rundown home to renovate.
A bank may not want to finance the home because selling a property in disrepair to recover losses if the owner defaulted could be difficult. In that scenario, a private lender that is able to stomach the risk is a great short-term solution to get financing for a few months to complete renovations before turning to a bank.
However, he says people are also turning to private mortgages as a desperate way to hang on to a home they can no longer afford because they don’t want to miss out on the rising value of property in Canada.
There can be cases where a private mortgage can help if you’re struggling to afford your home, but Mr. Larock warned borrowers to tread lightly and use the services of a broker that can be candid about the risks around private mortgages.
“If the person you’re talking to isn’t giving you a candid assessment of the risk, then that can be a warning sign,” Mr. Larock said.