The Bank of Canada recently lowered its key interest rate by 25 basis points to 4.75%, marking the first rate cut since March 2020.[1] This development presents both opportunities and risks for private mortgage lenders. In this article, we’ll explore how you can navigate these turbulent times, protect your investments, and ensure profitable lending practices.
The interest rate cut is part of a broader effort to stimulate the economy amidst ongoing economic uncertainties. While lower interest rates can make borrowing more attractive and potentially reduce the chances of mortgage defaults, they also have significant implications for private mortgage lenders. Despite this recent decrease in interest rates, it is important to bear in mind that the current mortgage delinquency rate in Ontario has climbed significantly, increasing by a staggering 135% since the pandemic.[2]
Many Canadians are unable to pass the rigorous stress tests required to qualify for a home loan from institutional lenders, leaving many to turn instead to private lenders. Data from the Canada Mortgage and Housing Corp showed that nearly 1% of mortgages from private lenders were delinquent in the third quarter of 2023, compared with the industry-wide rate of 0.15%.[3] LandBank Advisors studied over 1,000 mortgages issued between 2020 and January 2024 and found that about 90% of home owners in the Greater Toronto Area who had taken out mortgages from private lenders were forced to sell their homes due to default [4]
As more people turn to private lenders and defaults increase, this trend becomes particularly concerning. For those providing second and third mortgages, these subordinate positions in the event of default can result in minimal or no recovery, especially with declining property values.
Given the current economic challenges facing property owners, protecting your investments requires strategic measures. Start with thorough due diligence by ensuring property valuations are accurate and up-to-date to assess the true value of the collateral securing your loan. Additionally, evaluate the borrower’s credit history, income stability, and overall financial health. While private lenders face fewer regulations than institutional lender and are not require clients to pass federally mandated mortgage tests, assessing creditworthiness remains essential for determining a borrower’s ability to repay the loan.
When lending to a corporation, it is crucial to insist on personal guarantees from the principal owners. This ensures that if the corporation defaults, the personal assets of the guarantors can be pursued for repayment. In any event, another key strategy is maintaining a conservative loan-to-value (LTV) ratio. We recommend an LTV ratio of up to 80%, meaning the loan amount should not exceed 80% of the property’s appraised value. This conservative approach provides a cushion in case property values fluctuate.
It is also important to be aware of the legal protections and remedies available to private mortgage lenders. In Ontario, private mortgage lenders can pursue foreclosure or power of sale to recover debts. Understanding these processes and their timelines is essential for protecting your interests. In some cases, negotiating with borrowers can lead to mutually beneficial settlements, which can be a more efficient way to recover your investment compared to lengthy legal proceedings.
Despite the risks, today’s interest rate cut presents several opportunities for private lenders. Lower interest rates can make borrowing more attractive, potentially increasing the demand for private loans. Property owners with existing mortgages may seek to refinance, offering opportunities to lend to borrowers with better credit profiles.
With the increasing rate of mortgage defaults, navigating the current landscape demands careful planning and strategic action. As a private mortgage lender, it’s essential to stay informed, perform thorough due diligence, and implement effective risk mitigation strategies. The recent interest rate cut by the Bank of Canada introduces new opportunities into the market. By taking proactive measures, you can safeguard your investments and seize these opportunities.
[1] Bank of Canada, “FAD Press Release – 2024-06-05” (5 June 2024), online: https://www.bankofcanada.ca/2024/06/fad-press-release-2024-06-05/.
[2] Better Dwelling, “Canadian Mortgage Delinquencies Surge Up 135% in Ontario: Equifax” (date of publication not provided), online: https://betterdwelling.com/canadian-mortgage-delinquencies-surge-up-135-in-ontario-equifax/#google_vignette.
[3] Canada Mortgage and Housing Corporation, “Residential Mortgage Industry Report Spring 2024” (2024) online: https://assets.cmhc-schl.gc.ca/sites/cmhc/professional/housing-markets-data-and-research/housing-research/research-reports/housing-finance/residential-mortgage-industry-report/2024/residential-mortgage-industry-report-spring-2024-en.pdf at A4.
[4] Reuters, “Risk of Mortgage Defaults Puts Spotlight on Canadian Non-Bank Lenders” (1 February 2024), online: https://www.reuters.com/world/americas/risk-mortgage-defaults-puts-spotlight-canadian-non-bank-lenders-2024-02-01/#:~:text=LandBank%20Advisors%20studied%20over%201%2C000,out%20mortgages%20from%20private%20lenders.