If you’re thinking about lending your own money on Canadian mortgages, there are foundational concepts you should understand before you start. Private lending can be a strong, reliable investment when done properly. But it can expose you to serious risk if you don’t understand the fundamentals.
My name is Alexis Assadi, the founder of Assadi Private Capital. I’ve been a private lender in Canada since 2013, and in this article I’ll discuss six crucial concepts that every private lender should know before funding their first deal.
Mortgages Are Legal Instruments, Not Loans
Let’s begin by clarifying a significant misconception about mortgages. A mortgage, itself, is not a loan. It is a legal instrument that secures a loan against real estate. It is registered with the Land Titles Office and prevents the property from being transferred or refinanced without being repaid. It’s public record and is there for the lender’s protection.
In everyday language we say things like “My mortgage payments are $3,000 a month”. But that’s not technically accurate. A correct statement would be “My loan, which is secured by a mortgage in favour of a lender, requires payments of $3,000 a month.” Mortgages and loans go hand-in-hand, but they are not the same. A loan is a debt, while a mortgage is a security mechanism registered on real estate.
Mortgage Rank
Multiple mortgages can exist on a single property. There can be first mortgages, second mortgages and third mortgages. In fact, you could theoretically register an endless amount of mortgages, though I’ve never seen more than 3. This takes us to the concept of mortgage priority, or mortgage rank.
Mortgage priority refers to the lender’s position on the real estate they’ve secured as collateral. Since numerous lenders can secure their loans over one property, mortgage priority clarifies the order in which they get paid.
I’ll illustrate this with an example. Jena borrows $200,000 from a bank to buy a house. As security for the loan, the bank registers a mortgage on the property. It is the only mortgage over the asset, so it’s in first position and can be called a first mortgage.
2 years later Jena needs $50,000 to renovate the house. She borrows it from you, and you also place a mortgage on her property to secure your loan. Your mortgage, however, is behind the bank’s since you registered it later. You cannot skip the line and go ahead of the bank. Your mortgage is in second position and is known as a second mortgage. To be clear, the reason you can’t jump ahead of bank is because their mortgage was registered first, not because they have special status as a bank. Any lender can go in first position.
A first-position lender gets paid first when the real estate is sold or refinanced. A second-position lender gets paid only after the first is made whole. So in our example, when Jena sells her house, the proceeds first go to cover the bank’s loan. Then, they go to pay your loan. If Jena borrowed from a third lender, that lender would be paid after you. She keeps the remaining proceeds after all registered debts are paid off.
Mortgage priority is an indication of risk. As you move down the chain, your risk increases because you’re relying on the senior lenders being paid out first. If there isn’t enough equity in the property then the mortgage won’t protect you. Always verify with your lawyer your intended position on title before advancing funds.
Assessing Your Collateral Through LTV
To help ensure you have enough of an equity cushion, you need to know about the loan-to-value ratio, or LTV. LTV tells you how much debt is secured against a property when compared to how much it’s worth. You calculate it by dividing the debt by the price of the real estate.
For example, if you lend $300,000 against a house worth $400,000, your LTV is 75%. If there is already a first mortgage on the property of $50,000 and you are in second position, then your LTV is 87.5%.
A mortgage is not the only debt that can placed on real estate. For instance, if a person owes property taxes or strata debts, they can also be registered against the asset. So can judgments from court. When you calculate LTV, it’s critical to include all registered encumbrances. Many people make the mistake of thinking LTV only applies to mortgages. It doesn’t. It applies to the total debt secured against the property.
Private lenders generally consider a 75% LTV to be an acceptable level of risk for saleable, marketable real estate. But that depends on the local market’s liquidity. A property in downtown Toronto is likely to sell faster and with more stable pricing than one in a rural part of Ontario. For unique real estate or properties that might generate fewer buyers, you might need to go lower than 75%.
Discrepancies Between Loan Balances and Registered Mortgages
As you know, a mortgage secures a loan against real estate. When your lawyer files it with the Land Titles Office, they indicate how much money the mortgage secures. However, there is often a difference between what’s owed and what’s registered on the property.
For instance, suppose you see a first mortgage registered on title for $150,000. But when you look at the borrower’s loan statement, which you requested during due diligence, the balance owing is only $100,000. Why is there a discrepancy?
There can be several reasons. One could be that a $150,000 loan was advanced and a mortgage for that amount was registered. The borrower has since paid down the balance. Mortgage charges are usually not updated with the Land Titles Office as the debt decreases, so they often don’t perfectly reflect the current debt.
But while there’s a $50,000 discrepancy, you don’t necessarily have $50,000 of extra equity to rely on. The first lender may still be able to advance additional funds under that same mortgage instrument. After all, they are secured up to $150,000 because that was what the mortgage indicated. It might be a line of credit that can be drawn from and put back. You only get an accurate understanding of what’s owed and what type of loan it is by confirming it with the lender and then comparing it to the registered mortgage. Your lawyer can help you with this.
If the lender ahead of you is able to keep funding under their mortgage, the LTV could continuously increase. To mange this risk, private lenders often request a document called an undertaking not to advance. This is a simple agreement where the first lender confirms they won’t lend any more money. In my experience, banks and credit unions will usually agree to this, especially if they have a good relationship with the borrower.
How Property Taxes and Strata Debts Can Threaten Private Lenders
I previously mentioned property taxes and strata debts. These are particularly important. When a borrower is behind on them, it’s a sign of financial problems or mismanagement. But beyond that, unpaid taxes and strata fees can actually supersede registered mortgages in priority. That means a municipality or strata corporation could sell the property for arrears and get paid before you.
As such, you should check the property tax and strata fee status as part of your due diligence. If there is anything owing, you should require them to be paid. You might even pay them yourself and include them in the balance of the loan.
For example, let’s say you were planning to lend someone $70,000 but you see there are $2,000 in unpaid property taxes. You structure your agreement so the borrower receives $70,000 and you pay off the $2,000 in taxes. The borrower owes you $72,000. This arrangement is relatively common in private lending.
Exit Strategy
Finally, always consider the borrower’s exit strategy. How are they planning to repay your loan? Will they refinance with a bank once their credit improves? Do they plan to sell the property? Are they expecting a large payment, like an inheritance or legal settlement?
Understanding the exit strategy from the beginning is essential. If the borrower plans to sell, you’ll want to understand how realistic that plan is based on local market conditions. How quickly are similar properties selling, and at what price points? If their plan is to refinance, consider whether that’s actually feasible given their credit profile and income situation. Make sure you have a good grasp of how likely the exit will be.
Summary and Free Resources
So we’ve discussed six core concepts for Canadian private lenders: mortgages as an instrument, security position, loan-to-value ratio, registered versus owed debt, taxes and strata debts, and exit strategy.
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