While they can be used for purchases, one of the most popular borrower uses of private mortgages is second mortgages, which can supplement bank financing (Many banks do not grant second mortgages). This could be the case if the borrower qualifies for 75 per cent LTV on a mortgage from a bank, but needs an extra 10 per cent to purchase a property.
Real estate investors turn to private second mortgages for a variety of reasons. A common scenario is an investor who does “fix and flips” and only needs money for a short period of time before re-selling a property.
Another instance is when the investor wants to buy a distressed property – a foreclosure, for example – and fix it up. Because banks often won’t touch these types of properties, an investor can buy with private funds and once the property is fixed and producing a cash flow or is ready to sell they can access cheaper funds from an institutional lender.
Private Second Mortgages for the investor, we’re often seen as that short term solution – it is a stop gap that the banks can’t offer.
Property investors might also find themselves in a situation where their investment property is not bringing in the current market value of rent and may need time to renegotiate leases or complete renovations that will allow them to charge tenants higher rents. In this case, they could take out a second mortgage with a private lender and once the issue is solved, they could find more conventional financing elsewhere.
Another reason for using a private second mortgage could simply be that a borrower is turned away from the bank or the bank only wants to finance a t a lower loan to value because they have too many properties in their portfolio. That’s where private second mortgage financing on investment properties comes into play because borrowers might not have enough of a down payment to purchase another property.
The Costs of Private Second Mortgages
Although private mortgages can help borrowers get out of sticky situations, there are additional costs to consider.
First up is the higher interest rate, which can range from 7% upwards of 20 per cent. Lenders weigh the interest rate based on the loan to value needed, the property location and the overall risk factor of the loan.
Most private mortgage lenders charge between 12 per cent and 15 per cent for a 90 per cent LTV mortgage, but stresses many of them still only want to go up to 80 or 85 per cent. Since interest on income-producing properties is tax-deductible, it can provide relief from higher interest rates.
Other costs borrowers have to be aware of with a private mortgage are lender fees, mortgage broker fees, legal fees and an appraisal if a recent one isn’t available.
There are also fees from the lender on Private Mortgages general rule is the higher the LTV on a private mortgage, the higher the fee.
Mortgage broker fees will generally be similar to the lender fee, and often times there are also additional charges for pulling out of a private mortgage early, although terms generally don’t exceed a year or two at the most.