Over the years, I’ve made plenty of comments about how I’m in the private mortgage business. I once even wrote about it in pretty generic terms.
Questions have slowly trickled in from readers who are interested in private mortgages. How did I get involved in the business? What kind of interest rates can you charge? How do you decide who to lend to? And most importantly, how do you sleep at night?
(The answer to that last question is quite poorly, at least lately. It’s hot and I’m not allowed the air conditioner)
So I thought I would create a little mini how-to guide when it comes to the private mortgage business. We’ll go over how I got into it, the underwriting process, and all sorts of other jazz. I’ll show you actual deals I’ve done–with any personal details edited out, of course. Nobody wants to get sued.
Let’s get started.
Entering the business
I’ve been in the private mortgage business for awhile, starting back in approximately 2004.
I’d like to say I had some genius inspiration and the idea came to me one day, but it wasn’t like that. I had rental real estate at that point, and I knew there were certain borrowers the banks wouldn’t touch. Lending was way less lenient back then. HELOCs basically didn’t exist, at least here in Canada.
My dad and I began discussing it, although not really that seriously. After a bunch more research about how the private mortgage industry worked, we then approached a lawyer to make sure what we were thinking of doing was, in fact, legal. I wasn’t very good at using Google in 2004, apparently.
Shortly after deciding to get into the business, we happened to meet the only mortgage broker in town. We asked him if there was any demand for our service. He wasn’t sure, but if he found a deal he thought would interest us he would let us know.
We didn’t have to wait long. A month later we had done our first deal. Six months later we had done six more.
Most of the deals went something like this. A guy owns a house that’s worth $150,000 with a $60,000 mortgage on it. His credit is bruised, so the bank refuses to lend him any additional cash. We’d do a $15,000 second mortgage, lifting his total indebtedness to $75,000. That’s a loan-to-value ratio of 50%.
We spent a lot of time focusing on loan-to-value ratios. As a mortgage lender, the worst case scenario is having to foreclose on the place and being forced to sell it. As long as there was enough equity left over to pay a Realtor, legal fees, and get our capital back, we were happy. Thus, we set a loan-to-value ratio limit of between 70 and 75%.
The best part was the interest rate. We were getting 18% annually on our money, a reflection of higher overall rates and no competition in town. If you wanted a second mortgage back in 2004 in my neck of the woods, there was only one option.
We’d also charge fees on top of the 18%, with most of them going back to the mortgage broker for his commission. There would be enough left over to cover legal fees to enter into the transaction–which we always cover–plus a few hundred bucks for our time.
The broker left town, and business slowed a bit. We began to get known as the guys who would do alternative financing, and the calls would trickle in. Lending guidelines also started getting looser, meaning some of our borrowers could go back to the bank and qualify. So we didn’t do a lot, at least compared to the glory days of 2004.
One of the reasons why I became a mortgage broker in 2007 was to capitalize on our unique little business. I’d take a mortgage application, realize there was no hope of the borrower getting something conventionally, and see if it was a deal I was interested in.
I said no to most, since they were people with terrible credit who had only barely managed to scrape together a 5% down payment. But there were a few that I did do. Finally, I was hitting the big time.
A few things have changed from the glory days of 2004-2008.
Firstly, the interest rate charged has gone down significantly. 18% has been cut down to 8-10%, depending on the borrower, loan-to-value ratio, and location of the property. The better the risk, the closer the rate is to 8%.
There’s still no mortgage broker in town. A few have come and went (including yours truly), with nobody really doing much business at all.
We’ve changed our marketing slightly. We still depend heavily on word of mouth, since we’re still the only guys in town who are doing this type of lending. We’ve also done a bit of Facebook and Kijiji advertising, with a certain amount of success. The problem with advertising is each ad sends a certain amount of crap our way.
When you’re a higher-risk lender, you get a lot of people who are absolutely maxed out. They’re easy to say no to, but it still takes a certain amount of due diligence before they’re officially rejected. In 2016 in Alberta, we’re meeting more and more of these people.
Overall, we’re busier than we’ve been in a while. More and more people are struggling, and banks have responded by cutting off many people’s access to credit. For us, this is a good thing.
The underwriting process
Oh boy! It’s what you’ve been waiting for!
And because I like you guys, I’m not going to give you just one case study. I’m going to give you two!!!!!!!!!1
Geez, don’t act so excited.
Case study #1: Debt consolidation
Certain details have been changed to protect my ass from getting sued.
Meet Rob and Candace. They’re in their early-50s with two kids who have grown up and left home, hopefully forever. They sold the family house and downsized into a smaller place, getting rid of the mortgage in the process. Neither of them work glamorous jobs; Rob works as a laborer for the local government and Candace works at a local drugstore as a pharmacy assistant.
They live a reasonable life. Both drive relatively new, financed cars. They put a vacation on their credit card, content to pay it off over six months. Rob likes to do a little bit of work to the house on weekends.
Within a year, both decided to finance new (used) cars. Rob missed a bit of time off work when he got injured. Credit card bills were starting to add up. Suddenly, they realized that close to $1,000 per month was going out the door in high-interest payments every month.
So they called me. Could I help them out?
They were looking to borrow $25,000 to consolidate the following debts:
- $9,000 car loan A at 18% annually
- $10,000 car loan B at 20% annually
- $6,000 in various credit cards at 18-29% annually
Payments for the two vehicles alone were more than $800 per month. They were making nice progress on these loans, but the huge payments were creating cash flow issues.
This is exactly the kind of private mortgage I like doing. Here we have two gainfully employed people who just simply got in over their heads. Their house, which is fully paid off, was worth $110,000 in 2011 when they bought it. Rob has improved it since then, but to be conservative we’ll say it continues to be worth $110,000.
To verify the value of the house, I’ll do any one of a number of different things. I might talk to the Realtor who sold them the place. I’ll look up assessed values from the city. I’ve even been known to take a drive and tour the place personally.
I’ve never actually had a house professionally appraised, which I think would be a waste of $500. I like to compare it to value investing. If I’m willing to do a deal if the place is worth $110,000 but I’m not at $120,000, then it’s a deal I shouldn’t be doing in the first place.
In the value investing world, cheap stocks tend to jump out at you. They’re ridiculously cheap, no matter how you view it. I look at these mortgages in a very similar way. $10,000 in property value in either direction doesn’t matter all that much.
Back to the deal. I was looking at lending $25,000 against a property that was worth $110,000. That’s a loan-to-value ratio of 22.7%. They could comfortably afford the $500 per month in payments too. So I quoted them a rate of 8%, which is the lowest I’m willing to go. I felt very comfortable doing this deal.
Once we iron out all the details, I get the borrowers to sign a commitment letter. It sums up the whole deal in one document. I have certain conditions, which include:
- Being added to the home insurance policy as first (or second) loss payable
- Making sure the property taxes are paid up
- Putting in any prepayment penalties
- Outlining late and NSF cheque fees
- Any loan fees
Let’s take a minute to point out why these conditions are important.
Home insurance is easy. If the place burns down, Nelly wants to get paid. Without the clause on the insurance policy, I have to count on the borrowers paying me out. Since I would still technically have a loan against the land, I’m not sure they’d be forced to pay me. So I add that clause.
If the borrower doesn’t pay the property tax for years at a time, the city can try to auction off the property to get paid. In Canada, bidding has to start at assessed value, so at least I know somebody isn’t about to buy my property for $2,000 in unpaid taxes. But mostly, I just want my borrowers to pay the damn taxes.
I used to put in three month interest penalties for borrowers who pay the loan off early or make huge lump-sum payments. I’ve since taken that out. People like knowing they can pay the loan off early. Most don’t, but they like holding onto the hope.
Many people do pay faithfully for a few years and then refinance with another lender. It’s always a little bittersweet when that happens, but I don’t want to penalize them too much.
There are also late fees. One thing you have to keep in mind before doing a private mortgage is people will be late. There’s a reason why their credit is bruised in the first place.
So if a borrower is a few days late once every few months, I don’t charge late fees. If the borrower is going through a tough time, I’ll waive the late fees. If a borrower is chronically late, then you better believe their ass is getting charged late fees.
Late fees are anywhere from $10 to $100 per payment. I’m closer to the bottom of that range since I’m trying to be a nice guy (ed. note: you are???). I know other private lenders who are closer to the top of the range because they view it as a way to ensure they get paid. In other words, if the borrower doesn’t pay, they want that jerk to suffer.
Depending on the private mortgage, I’ll do anywhere between $1,000 and $1,500 in a loan fee. A normal deal will cost me $600-$700 in lawyer fees alone, so it’s not like I’m making bank on the fee. Besides, doing the deal through a lawyer adds legitimacy to it. Borrowers like it and don’t usually get too pissed off at the fee.
Once the commitment letter is signed by both parties, it’s forwarded to my lawyer. They then prepare the actual mortgage documents, register the lien on title, and all that fun stuff. This takes 2-3 weeks and then the deal is done.
Case study #2: An actual bailout
Next up we have Larry and Crystal, a married couple in their late-50s. Larry works at a car dealership doing oil changes and other simple repair work. Crystal is the front desk clerk at a local hotel. Together, they make approximately $50,000 per year. They have a freeloading son living at home even though he’s close to 30.
Larry gets sick and can’t work for a few months. Crystal makes due on her own, but there’s one thing they can’t afford while Larry’s on the shelf–the mortgage. They quickly fall three months behind. Things are so bad freeloading son even considers getting a job.
Larry eventually recovers and goes back to work. They start to work on getting caught up on the mortgage. But before they have a chance to catch back up, it turns out their five-year term is up. And since they’re behind, the bank doesn’t want to renew. No other legitimate lender will touch them because falling behind ruined both their credit scores. Not that these scores were good in the first place, but still.
The total owing was approximately $65,000. The house, depending on who you ask, is worth between $135,000 and $160,000. The value went up as soon as the freeloading kid went to smoke weed at his buddy’s place.
At $700 per month at 8%, we were looking at a private mortgage with an amortization of just over 12 years. $700 per month was also a mere 14% of their gross salary, well within the acceptable range. And the loan-to-value ratio was below 50%. These were all working in my favor.
So I did the deal. That was five years ago and they’ve never missed a payment. They’ve been a few days late a few times, but nothing worth getting upset about.
Let’s wrap it up
Oh hey, 2,300 words. I guess when it comes to the private mortgages I’m like your rambling grandpa.
Anyhoo, if you have any questions the comment section is all yours. Hey, I’ll even answer them.