Once upon a time, homeowners could easily borrow up to 85% of the value of their home. Although not quite as easy anymore, here’s what you need to know to get a private or second mortgage.
Everyone has been talking about how banks and major lending institutions have changed their lending practices due to the coronavirus pandemic. But very few are talking about the impact of the pandemic on private mortgage lending. That’s surprising, considering alternative and private lenders hold approximately $14 billion of outstanding Canadian mortgages. Data from CMHC also suggests that figure will continue to grow in 2020.
Why Bank Mortgage Rules Changed
Without a doubt, the coronavirus pandemic is affecting the Canadian housing market. The problem is that there are many unknowns at this time, such as: volatility in demand, shrinking supply, and the unknown effects of another possible pandemic wave. For example, according to the Toronto Real Estate Board, new listings fell three per cent to 11,789 in August, while active listings fell 11 per cent to 15,870 over the same period.
As a result, in May of 2020, CMHC (Canada Mortgage and Housing Corporation) was forecasting a 9% to 18% decrease in house prices over the next 12 months. In order to protect future home buyers and reduce risk, CHMC changed its underwriting policies for insured mortgages. Effective July 1, the Gross/Total Debt Servicing (GDS/TDS) ratios decreased to 35/42, and the minimum credit score increased from 600 to 680 for at least one borrower. For many buyers, this has reduced the amount they can borrow.
Here are a couple of excerpts from a letter to all CMHC approved lenders (i.e. banks and institutional lenders), dated August 10, 2020, reminding banks of their unchanged stance:
“We have sustained a reduction in our market share to promote a more competitive marketplace for your benefit. However, we are approaching a level of minimum market share that we require to be able to protect the mortgage market in times of crisis. We require your support to prevent further erosion of our market presence.”
“We continue to believe house prices will fall, even in the face of recent activity, which appears to be the result of very low interest rates and a sharp reduction in new listings/supply vs underlying demand.”
Private Lenders Follow Suit
These concerns are also shared by private lenders. In March, all private lenders had a knee-jerk reaction to the rise of the pandemic. Most lenders scaled back their lending, limiting loans to 50-65% of the value of the home (also called LTV – Loan-to-Value ratio). Many lenders ceased lending altogether. Needless to say, it was very difficult to get a private mortgage in March!
The reason for the massive scale back is simple. Private mortgages are not insured. They are secured only by the equity in your home. The more equity you have in your home, the more secure the lender feels. This explains why many lenders can lend to a borrower who has bad credit, or doesn’t meet stringent bank criteria.
A low LTV ratio provides a sufficient buffer to protect the lender’s money, should the real estate market drop and the borrower default on the mortgage.
Understanding The Exit Strategy
A private lender must also consider how the borrower will repay the loan at the end of the term. Typically, the borrower can take this opportunity to repair their credit, or fix whatever situation they are in. This will ultimately allow the borrower to refinance their home with a bank or “B-lender”. Private lenders know that the refinancing limit is 80% LTV at the banks.
To illustrate, consider this example. Mary owns a home in Toronto, appraised at $1,000,000. She obtains a private mortgage of 80% LTV, or $800,000. If the real estate market drops 10% (as potentially is forecasted by CMHC), her home value would decrease to $900,000. Her mortgage LTV is now $800k/$900k = 88.9%, a risky situation for the lender! Risky, because there would be no opportunity to refinance this mortgage with a bank or B-lender.
Now let’s assume the private lender instead limited their current lending to 70% LTV. Mary can now only obtain a private mortgage of $700,000. If the real estate market drops 10%, her new LTV would be $700k/$900k = 77%, an acceptable risk. This would enable Mary to refinance her mortgage with a bank or B-lender at the end of the term (should she meet all the other bank requirements as well, of course).
Borrowing Limits Slowly Returning To a “New Normal”
Several alternative lenders (e.g. MICs – Mortgage Investment Corporations) and private lenders have been gradually increasing their LTV limits. As of September 2, 2020, first mortgage limits have been increased to 75%, and second mortgage limits have increased to 80%. A very small handful of private lenders have returned to 85% LTV. However, they all remain cautious, and may require additional documentation for underwriting a mortgage application.
The Key to Getting a Private or Second Mortgage Today
A well connected mortgage broker will be able to search and obtain a private or second mortgage that is right for you.
As a brokerage, we pride ourselves in having a strong and vast network of lenders. We stay on top of rapidly changing rules, LTV limits, and requirements to be able to deliver the service and solution that you require. This helps you save time and money. Contact us for details!