What is private mortgage lending?
Private mortgage lending in Canada refers to borrowing money from private persons or companies as opposed to traditional financial institutions such as banks or credit unions. Private mortgage financing is an option for people and organizations who may not qualify for a loan from a conventional lender or who require funds immediately.
Is private mortgage lending safe?
Private mortgage lending is not a regulated activity in Canada, so it’s common to find incentive schemes and tiered referral fees paid to accountants, lawyers, agents, and a middleman who helps facilitate the private mortgage between the borrower and the lender.
What are the risks of private mortgage lending in Canada?
Default Risk
One of the greatest hazards for lenders is the possibility of losing their investment if the borrower defaults on the loan. Moreover, they may not have the same level of protection and legal protections as conventional lenders. This also means that the lender may not be able to recover the whole loan amount if the borrower defaults.
If the property's value decreases in the future and the borrower defaults, the lender may be left with a property whose worth is less than the amount of the outstanding mortgage.
Lack of regulation
Private mortgages are not regulated in the same manner as conventional mortgages, therefore lenders may not have the same level of protection and legal rights. This also means that private mortgages may be issued and serviced with less oversight and less transparency, which can increase the risk for investors.
Interest Rate risk
If interest rates rise and a private mortgage lender is unable to adjust the interest rate on a mortgage loan to reflect these changes, the loan may no longer be profitable.
Limited Diversification
Private mortgages typically necessitate a substantial investment and are exposed to a highly concentrated group of borrowers with poor credit.
Lack Liquidity
Private mortgages are often illiquid assets since they are typically locked up for long terms. Also, selling a mortgage can be a complex and time-consuming procedure. This can make it difficult to quickly access the investment's cash value or sell the investment in the case of an unforeseen need for cash or if the investor desires to exit the contract.
It's also crucial to remember that while private mortgage returns can seem substantial when you're first told about it, they also carry a high level of risks and returns are commonly significantly reduced after taxes, legal costs, and accounting expenses to maintain the mortgage. You'll likely find yourself better off with other investments.
In general, stocks may be considered to be a better investment than private mortgages for several reasons:
Diversification: Due to the variety of stock types and industries available for investment, stocks give investors the chance to best diversify their investment portfolio. This can lessen the effects of any one investment performing poorly by spreading risk across a variety of investments.
Liquidity: Stocks are significantly more liquid than private mortgages. This means that it is easier to adjust positioning, plan more accurately and more easily access the cash value of the investment.
Higher potential returns: long term, stocks have the potential to deliver higher returns than private mortgages.
Tax-efficient solutions: Working with a financial advisor can help ensure your investments are either tax-deferred, tax-free, and/or tax impact reduced.
Regulation: Securities rules that govern stocks give investors better protection in the event of fraud and poor management. Contrarily, as private mortgage financing is unregulated, there may be less transparency in the way that private mortgages are provided and maintained.
Before investing in private mortgages, investors should conduct extensive research and understand the dangers involved. Before making any investing decisions, it is recommended to speak with a financial advisor.
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Gianluca Folino
Financial Advisor, Manulife Securities Incorporated
Life Insurance Advisor, Manulife Securities Insurance Inc.
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