Private Mortgage-What is a
A private mortgage is a loan product secured against property. It represents an alternative to the mainstream property mortgage loan offered by banks and other financial institutions. A private mortgage is granted by a private individual, acting alone or jointly with others, rather than a bank or lending firm. In other words, the lender extending the private mortgage loan is an individual, not an institution.
Private mortgages are considered asset-based loans since the key focus of lenders is on the security represented by the underlying property. For these loans, the security or collateral offered to support the loan is more important than the income or cash flow of the borrower. This collateral focus is explained by the higher probability of borrower default and hence the lender's heightened concern to ensure the loan amount, plus outstanding interest, can be recovered in the event of default.
Private mortgages are considered low documentation (low doc) loans since the lender places few demands on the borrower in terms of proof of income. Private mortgages also have no, or very low, break costs. This means they can be repaid at short notice, usually with as little as thirty days notice.
On the demand side, private mortgage loans are attractive to sub-prime borrowers who have difficulty in obtaining a conventional mortgage loan. Sub-prime borrowers include people who are already carrying large debts relative to their cash flow, have difficulty in demonstrating cash flow or have a low credit score. In North America, credit scores range from a minimum of 300 up to a maximum of 850. A score less than 620 usually marks an individual as a potentially risky borrower with whom banks are reluctant to deal. Property owners facing foreclosure by a mainstream bank may be able to obtain refinancing via a private mortgage.
On the supply side, private mortgage loans are attractive to lenders who have a relatively high risk tolerance. Reflecting the greater default risk of private mortgage applicants, lenders usually require a higher interest rate, a shorter loan period and a larger upfront deposit or equity participation - sometimes as high as thirty percent - in the property by the borrower compared to conventional mortgage loans.
Private mortgages offer borrowers several advantages. Firstly, and most importantly, they provide access to credit, albeit on less favourable terms than conventional loans. Without private mortgages, some would-be borrowers would not be able to obtain financing at all. Second, the information burden placed on borrowers is low. Borrowers are asked to provide a minimum of financial records for lenders to review. Thirdly, the overall application and approval process is usually short, sometimes as quick as seven days. By comparison, a bank decision on an application for a conventional mortgage loan can take from 60 to 90 days. Fourthly, private mortgages can usually be repaid in full, at short notice, without penalty to the borrower.
Private mortgage lenders recognize they are transacting with higher risk counterparties. However, they receive a higher interest rate, sometimes as much as six percentage points above conventional loans. Even though the default rate actually experienced by a lender may eventuate to be higher than on conventional loans, private mortgage lenders they anticipate generating an adequate return on a portfolio basis.
Private mortgage contracts are negotiable instruments. They can be bought and sold. Once a loan agreement has been finalized, the lender (mortgage holder) can divest that asset by on-selling it to another investor, albeit at a discount to its net present value. However, the secondary market for these loans has few participants. It is thin with poor liquidity relative to formal organized markets such as those for listed company shares and government bonds.
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