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Thinking of an alternative lender? What it could mean for your mortgage

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As economic conditions make it harder to qualify for a mortgage, Canadians are increasingly looking to alternative lenders, particularly amid high interest rates.

Observers have made note of this trend in alternative lending for years now.

But it comes as the Bank of Canada has increased its key rate for a year, finally holding it at 4.5 per cent as of this month, in an effort to control inflation although more rate hikes are possible.

CTVNews.ca looks at why Canadians are seeking private lenders and the potential benefits and risks attached to them.

WHAT ARE PRIVATE MORTGAGES?

Those who aren't able to qualify for a traditional mortgage, such as through a bank or credit union, may look at a private mortgage.

Private mortgages are considered to be a short-term solution, ranging for as long as a year or two, the Financial Services Regulatory Authority of Ontario (FSRA) says.

The Canada Mortgage and Housing Corp. (CMHC) found that between 2015 and 2020, alternative lenders were the fastest-growing segment in the Canadian mortgage industry, increasing their portfolio from an estimated $9 billion to $15 billion.

Greater demand, rising house prices and low interest rates at the time were all factors, the CMHC said, although these have been affected recently by COVID-19.

In a report from November 2022, the CMCH found that a larger share of borrowers are renewing their mortgages with an alternative lender.

The figures show that in the third quarter of 2022, 33 per cent of borrowers renewed with an alternative lender, compared to 29 per cent one year previous and 31 per cent the year before that.

The FSRA released a poll in February that found the most popular reasons why borrowers turned to private lenders were more flexible terms, an easier application process and the belief that it is a better option for people who are self-employed or don't have a steady income.

WHAT ARE THE BENEFITS AND RISKS?

The FSRA says while easier to obtain compared to a traditional lender, a private mortgage could mean higher interest rates, a lender fee, as well as additional conditions or restrictions.

"They are smaller lenders, but many are still national," Grant Powell, a mortgage expert from British Columbia, told CTV's Your Morning in December.

"Many have been in business for decades (and) they work with you on a case-by-case basis."

These lenders tend to have lower standards to qualify for a mortgage, which could be attractive for those with inconsistent credit, debt or employment, Powell said.

"For homeowners squeezed by rising rates and tougher lending guidelines, private lenders can appear to be a saving grace," Victor Tran, a mortgage and real estate expert for RATESDOTCA, said in a statement shared with CTVNews.ca.

"However, there are risks that homeowners need to be aware of when taking out a mortgage with alternative lenders. There are significant differences between taking a mortgage from a traditional lender and taking one from an alternative lender, and these differences can cost consumers more than they might think."

Where a person lives may also influence the fees they pay through a private lender.

As the FSRA points out, many private mortgage payments go toward servicing interest only.

"Alternative lenders can help homeowners that are really in a bind and are having trouble securing mortgage financing," Tran said.

"But they should be considered as a short-term solution and there should be a plan in place to eventually work with a traditional lender."

EXIT STRATEGY

Both the FSRA and CMHC recommend borrowers have a proper exit strategy to leave a private mortgage at the end of their loan term, given the potential challenges of having to pay higher interest rates for an extended period.

An effective exit strategy can include finding a mortgage with a traditional lender or selling the property.

The CMHC found in its November report that approximately 70 per cent of mortgage borrowers had an effective exit strategy compared to 72 per cent in 2021 and 2020. The corporation attributed this drop to fewer properties being sold by the end of the loan term.

Although it fluctuates year to year, around 80 per cent of foreclosures in Ontario involve properties with an alternative lender, the CMHC says.

"You are paying higher interest rates and you're charged the fee for placing the loan from two to five per cent of the mortgage amount," Powell said. "So make sure you do have an exit strategy because you only want to be in this kind of loan for I'd say one, two — maximum three years."

With files from CTVNews.ca Writer Natasha O'Neill and The Canadian Press

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