Over the years Banks and Credit Unions lending practices have changed and became stricter. Current market conditions further force the traditional lenders to err on the side of caution and reduce the amount of funds available for lending. Lastly, with lower appraisal rates and conservative lending practices, banks and credit unions may no longer approve a mortgage application they would have done in the past. What is a person to do when they require financing but do not qualify for a traditional mortgage? There are a few options currently available on the market each has their benefits and drawbacks. While borrowing from alternative lenders has its own risks associated, in some instances an approval could mean avoid default under an agreement of purchase and sale. The borrowers should do their research and know the details of each mortgage option before signing a commitment.
B Lenders and Higher Risk Borrowing
First option available to the borrowers, who do not meet the challenging criteria of the bank, on the market is a ‘B lender’ mortgage. A ‘B lender’ is a financial institution that has a more lenient lending criteria that helps individuals with lower credit score, self-employed borrowers or have less traditional income source. The benefits of working with a B lender is that they offer financing options that are not available through a Bank or Credit Union. Unfortunately, the higher the risk of lending the worse the lending terms will be. B lenders usually charge higher interest rates and often have lender fees, often 1% of the mortgage amount, associated with the mortgage. The term of the mortgage with a B lender can be negotiated from one to five years and is dependent on the borrowers’ credit worthiness and repayment ability. But, if the borrower cannot qualify for a traditional mortgage, a mortgage with a B lender would be the next best thing. Many borrowers use B-lenders as a temporary solution to their financial problems. Meaning that there was a reason why an individual did not qualify for a bank mortgage. If an individual has a lot of commercial debt and as a result has a lower credit score that is preventing them from refinancing with a bank, that individual could borrow from a B-lender, payoff their commercial debt and within a year “cure” their credit history. As a result, in a year, the borrower could qualify for a mortgage with the bank.
Vendor Take Back Mortgages
Another option may be available only for buyer borrower and it comes directly from the seller of the property. This type of mortgage is called vendor takeback mortgage (“VTB”). The seller of the property agrees to finance up to a certain amount (usually not more than 80%) of the purchase price. The drawback with a VTB is that the loan amount is at sellers’ discretion. Therefore, seller may only agree to finance 50% of the property and as such the buyer would be required to put down a higher down payment. The amount of financing does not come as a surprise and the terms of the VTB are usually negotiated with the seller at the same time as the agreement of purchase and sale is signed. Therefore, one of the conditions of purchasing the property is sellers’ commitment to lend the money to the buyer to purchase the said property. The terms of the VTB mortgage are negotiated between the buyer and the seller. Usually, the interest rate is higher but there are no additional fees associated such as broker or lender fees. Another shortcoming of VTB is that it is not readily available. In most cases the sellers usually require the funds from their sale to pay off their existing mortgage or have other financial obligations. Big benefit of a VTB is that qualifying criteria is fairly flexible, the main criteria is that the borrower have sufficient income to make payments. Should the buyer fail to make mortgage payment, the seller also being a lender can sell the property under a power of sale to recoup any and all loses. Individuals who seek out purchases with VTB usually had difficulties obtaining financing from a financial institution. Depending on the term of the VTB, that time allows the borrower to work out their issue and prepare for a refinance with a bank at the end of the VTB term.
Private Mortgages and Short Term Financing
Private mortgages are becoming more and more popular as the banks enforce stricter lending guidelines. Private mortgages are funded by individuals or corporations who use their personal funds. Usually, a mortgage broker is involved that connects a lender with borrowers based on lenders risk tolerance. The disadvantages for a private mortgage are higher cost of borrowing. With most private mortgages the borrower makes interest only payments and as such not reducing their principal amount. Therefore, after making payments through out the term of the mortgage, the borrower must return the full borrowed principal at the end of the term. Private mortgage is usually taken out for a shorter period of time. Shorter loan period means higher fees for the borrower including fees associated with refinancing, updated appraisal and legal fees. Other fees such as a broker fee as well as a lender fee associated with the transaction are also applicable when dealing with private mortgages. However, the benefit of a private mortgage is their flexible lending criteria, private mortgage lenders may loan to self-employed individuals, complicated deals with lower appraisals and faster turn around time to fund the deal. Private mortgage is usually seen as a last resort due to the fact that their high interest rates and higher set up fees. Similarly to a B-lender mortgage, private mortgages are taken out as a temporary solution until such time as the borrower is able to refinance with an alternative source.
Reverse Mortgages and Home Equity
Lastly, a reverse mortgage is a very specific mortgage that is available only to individuals who are over the age of 55 and do not currently have a mortgage on their property. Therefore, the borrower must have the house paid off in full before qualifying for a reverse mortgage. The amount available to borrow depends on the age of the borrower as well as the home value. However, if the borrower meets the lending criteria, the borrower may qualify for a loan up to 55% of their home value. One of the benefits of the reserve mortgage is that the borrower does not have to have good credit as long as the lending criteria is met. It is important to note that the borrower remains responsible for payment of their insurance and property taxes. The mortgage advance can vary between a lump sum payment or monthly smaller payments. This option allows borrowers to determine whether or not they need a lump sum for example to complete renovations, or simply a monthly stipend to assist with expenses. Best part of all is that the bank will not collect monthly mortgage payments due. This could be a double edge sward, as the payments are collected at the end of the mortgage term. One of the disadvantages is that a reverse mortgage reduces home equity. Because mortgage payments are not collected during the term of the mortgage, once the mortgage is matured, the payments are collected together with principal from the equity of the house. Therefore, it could leave an estate liable for payment of the mortgage diminishing inheritance. Furthermore, high fees and lower property values could lead to financial implications for the estate. For example, if the property is sold in when the market is at its lowest and the fees together with mortgage principal and interest payment are higher than the value of the property, the estate and in turn its heir, would be responsible for the shortfall needed to payout the reverse mortgage. It is important to note that depending to the term of the mortgage, that the interest compounds leading to significant amounts.
Why Legal Review Matters Before You Commit
One of the most important things when it comes to alternative lending is the importance of understanding the risks associated with each mortgage type. If you are considering taking out a mortgage with an alternative lender, review all the terms and conditions associated with the mortgage. If you are uncertain, please reach out to your mortgage broker and/or your lawyer and enquire about mortgage terms and its implications. It is just as important to create a plan or an exit strategy how you are going to switch to a Bank mortgage. Once you have a strategy and are working towards it, alternative financing could be a great temporary solution.
