The demise of subprime lenders combined with tightened credit has meant an increased demand for private mortgage funds. Erin Letson explores how brokers can navigate this altered private lending landscape
Since CMP ran a cover story on private lending in April 2008, it's been a tumultuous time for the private mortgage industry.
First was the disappearance of subprime lenders, leaving "non-A" clients with fewer borrowing options. This shake-up was followed by a sharp decline in housing values and credit availability from conventional lending institutions. Throw in updated rules on private lending (in certain provinces), investor uncertainty and a growing number of house foreclosures and it's easy to see why the landscape has changed.
"Generally, private lenders have become more conservative and careful and some have gotten out of the market completely, which I think is a good thing," says Rajan Kaushal, president of The Money Source, a private lending company in Toronto. "I think serviceability has become more of an issue and we're doing more due diligence now."
Matt Oberle, a BDM at the home equity lender Capital Direct, also says he has noticed a more conservative approach, adding his company is lending less due to tightened credit.
"We have to turn more clients down," says Oberle. "We're still subject to what the banks and financial institutions offer because they're the ones that ultimately have to pay out our mortgages when a client improves their situation."
And while mortgage investment corporations (MICs) were popular business ventures in recent years, several smaller private investors have backed out of the market since being presented with economic challenges, leaving more established private lenders a larger share of potential borrowers - and a growing number of mortgage professionals looking to them for money.
The new economy means many private lenders have implemented changes to reduce their risks, even though this generally equates to lower payouts for investors. A common scale-back among private lenders has been lower loan-to-value ratios on private mortgages.
"We've decreased our loan-to-values and that's because we're an equity-based market and we have no insurer behind us - we have to self-insure and so we have to protect ourselves that way," says Chuck McKitrick, owner and partner at Alta West. He adds that some deals are being scrutinized more closely depending on the property, such as condos in Edmonton, which recently took a hit in the real estate market.
Capital Direct Lending and Fisgard Capital Corporation have also reduced their LTV ratios to safeguard against further house value drops, especially since both companies have been increasing their client bases in the residential market. Fisgard president Hali Strandlund, who is based in Victoria, British Columbia, says while the company might have gone to 85% LTV a year ago, it has lowered that number to 75% on owner-occupied single family residential mortgages and 65% on rental properties. Oberle says Capital Direct has dropped its LTV ratio from 90% to 70%.
On top of LTV changes, the maximum amount private lenders will loan is decreasing. Robert Davis, CEO of the Oakville-based WealthBridge Corporation, says the company used to lend up to $650,000 on one property, but that number has been dropped to $500,000.
"No one wants all their eggs in one basket because they can get burned," he says. Decreasing home values have also meant that private lenders have to look at borrowers more closely. While they're still more flexible than institutional lenders - most notably when it comes to Beacon scores and employment - a client's ability to pay has become more important in determining if a deal will close, says Strandlund.
"When values were going up and up, the [borrower's] ability to pay was important but not paramount, whereas now we look at that very closely," she says. "We're looking at the serviceability of the loan as opposed to the straight equity."
Risky borrowers who may have obtained second mortgages or other higher yield mortgages in the past are also being overlooked more often due to both the economy and the fact that the subprime market has given private lenders new - and, in some cases, less risky - business. For example, McKitrick says borrowers in foreclosure are not being considered at this time even though
Alta West used to deal with those types of clients.
With subprime lenders out of the picture, many brokers and their clients are looking to private lenders to fill the gap, making for a more competitive market with non-bank and alternative lenders.
"We're seeing more volume than we've seen in the last five years," says Davis. "The No. 1 contributor is that there are less lenders doing non-traditional lending."
McKitrick says the competition for traditional subprime borrowers has increased between private lenders and alternative lenders, resulting in lower private lending interest rates, especially for first mortgages. At Alta West, these rates start at 8.99% - only about one per cent higher than many alternative lenders, he says.
"The loss of all the subprime lenders has opened up more territory for us," he says. "We're seeing a much better class of borrowers than we did a year or two ago because those deals, which would historically go to the subprime lenders, are now coming to us."
Fisgard, which was recently approved as a Royal Bank alternative lender, charges interest rates between 5.25% and 15% depending on the situation, says Strandlund, adding the MIC's rates are competitive with larger lenders.
"We are another source of mortgage funds for brokers and consumers even though we don't happen to be your typical conventional lenders," she says. "We'll look at any deal and price it accordingly."
While the disappearance of subprime lenders has given many private lenders more business to choose from, because these lenders weren't doing their business with due diligence, it has had some negative effects.
"Due to the subprime guys, we had to go lower than what we should have in our private pricing," he says. "Then all the subprime left and the market collapsed at the same time and now our pricing is probably higher than it should be and we're going to eventually - likely corresponding with the housing market - even out to a middle ground somewhere."
Working with private lenders
Strandlund says she likes working with mortgage professionals because they provide an additional layer of due diligence for potential borrowers. However, she stills sees some common mistakes made during the loan application process.
"For a private deal, we want the usual details and we also want the story," she explains. "Why are the borrowers coming to us? What other lenders have they already been to? Why did these lenders not approve them? It's key that brokers be accurate with their clients' information."
McKitrick also values detailed and accurate applications and says it's essential that a broker is sure of the value of the asset in a refinance situation.
"In this marketplace, the biggest factor killing refinance deals is that the broker is not doing their homework on value," he says. "They're taking their clients' word and that is a big mistake because the client is still presuming the value of their home to be at last year's pricing, but has probably dropped."
To get a better idea of a deal, McKitrick also asks for a borrower's land title - a simple step he says is often missed by mortgage professionals - and a comparative market analysis (CMA) from a realtor, which often replaces or accompanies an appraisal at Alta West.
"If I could give any advice to the mortgage broker, it would be to have a good package with the value included and to patiently work with the private lender because they have to do their own due diligence to determine whether it's a deal they want to do or not," he says.
Oberle recommends brokers who are new to the private lending industry check with lenders to see what documents they require and to get a sense of whether the deal will work.
"The biggest problem I run into is that brokers assume certain things and expect us to behave similar to banks and larger lending institutions," says Oberle. "They don't ask the questions, and the reality is we have a completely different infrastructure and that comes down to manpower, policies, responsibilities, guidelines - we are just a completely different business than A lenders, so there's going to be completely different expectations on our end."
Warning signs that should indicate to any mortgage professional that the client won't fit with a private lender include multiple bankruptcies, no filed income, a constant consolidation of debt and generally poor financial patterns.
Robert Davis of WealthBridge Corporation says he thinks private lending has a "tremendous future" in Canada, but stresses the importance of keeping fees reasonable and nottaking advantage of borrowers who are in weak positions.
"Private lending must be fair, it must be priced within reason or we simply create an industry that comes under the same scrutiny as some of those payday advance companies and that's not the type of industry we want."
Davis also sees a trend toward more educated consumers who will choose more established, reputable companies as opposed to the smaller private lenders, who have become less prominent in the market since the economic downturn.
Oberle forecasts that we're entering a period of rebuilding and thinks all the major changes in the market have already happened.
"I think everything is on the table now and we're still in reaction mode at the moment," he says. "We're going to be gradually going back to normal in the next couple of years."
With limited available credit and a growing number of "non-A" borrowers wanting to get into the housing market, it's becoming increasingly important for mortgage professionals to understand the role of private lenders and build relationships with them. As Kaushal of The Money Source points out, private lending remains important because it services niche markets like second mortgages, commercial first mortgages and construction that conventional lenders won't consider - not to mention the borrowers now shut out of subprime lending.
"Is there always going to be a need for private lending? Absolutely," he says. "We only have so many institutional lenders and there are some open gaps. Private lenders will fill them."