Private mortgage: Everything you need to know

A private mortgage may be a good idea if you don’t qualify for a home loan for a traditional lender. But with higher interest rates and fees, and potentially harsher penalties, they may not be for everyone. If you are on the fence, here is everything you need to know about private mortgages.

What is a private mortgage?

A private mortgage is an interest-only, short-term loan that you use to purchase a home. A private mortgage could be an easier loan to qualify for since they are offered by institutions or independent lenders. Private mortgages, which are similar to subprime mortgages, are usually a good idea for anyone who cannot secure traditional loans from banks and other financial institutions.

Because there is a better chance that private lenders will view your mortgage in terms of investment, they are less strict about background checks and credit history than traditional lenders. And if you are purchasing a unique property, you have a non-traditional source of income, or you do not plan to own the home for the long term, a private mortgage could make more sense. 

As shorter-term loans, private mortgages generally have amortization periods that last as little as six months to as long as three years. Borrowers typically find themselves in better positions to apply for a mortgage from a bank or other traditional lenders after making on-time payments throughout the private mortgage term.

How do private mortgages work?

A private mortgage is usually offered by mortgage investment corporations, individuals, and syndicates. To secure a private lender, you can either seek one on your own or use the expertise of an experienced mortgage broker who will be able to connect you with a private lender.

It is important to note that interest rates for private mortgages are usually much pricier than mortgages that are offered by banks and other traditional lenders. Those interest rates are higher usually because the payments that you must make on private mortgage loans are interest only. In other words, none of your payments are made on the principal with an interest-only mortgage. This means that, unlike a standard mortgage, the total amount that you owe does not lessen over time.

When applying for a private mortgage, you will be required to meet certain requirements, though it is still usually quicker and easier than qualifying for a traditional mortgage. Some of the requirements you will need to qualify for a private mortgage include:

Down payment. The minimum down payment you will need for a private mortgage is typically at least 15% of the purchase price.

Proof of income. You will have to prove that you have the income required to make your mortgage payments, which can get tricky for those who are self-employed. In those cases, you will likely need to provide extra documents.

A sellable property. This is because if you default on your payments, your private mortgage lender will need to ensure they can possess and possibly re-sell your home to get their investment back.

Advantages of private mortgages

While useful for some potential homebuyers, private mortgages might not be for everybody. Some advantages of private mortgages include: an approval process that is quicker; they are suitable for anyone with little credit history or even poor credit history; and they are open to anyone who does not have traditional sources of income.

Disadvantages of private mortgage

On the other hand, disadvantages of private mortgage include: higher interest rates; interest-only payments usually do not pay down your mortgage; added fees for commissions and setup; harsh penalties if you fall behind on your payments, because private mortgage lenders foreclose on properties faster than traditional lenders; and, since private mortgage lenders are not licenses, you can not be sure they have the same experience, education, and requirements as licensed mortgage lenders.

When is the right time to get a private mortgage?

Compared to traditional mortgage loans, a private mortgage offers higher rates and fees, and a shorter amortization period. To decide whether it is time for you to get a private mortgage, you might consider the following:

- You are crunched for time and need the money more quickly than you would get it navigating a traditional lender’s approval process

- A traditional lender will not approve you for a mortgage, or for a high enough mortgage, because you have bad credit history

- Until you are able to get the money from a traditional lender, you simply need a short-term loan; or

- Traditional lenders refuse to finance you for the unconventional home you want to buy, such as an inherited home that needs work, a fixer-upper, or a commercial property. In these cases, traditional lenders can be reluctant to finance.