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Second-tier mortgage lenders

Many people with credit problems or an unconventional employment history fear the only kind of loan they'd qualify for is from a shark named Paulie who operates out of the back room of a seedy bar.

But, such would-be homeowners are probably watching too many B-movies instead of reading about B-lenders. The reality is there are a slew of second-tier lenders willing to finance their mortgages, even if the big banks say no. All you have to do is ask.

"We seldom turn down purchases. We'll overlook a lot of credit issues and income issues provided the real estate is marketable," says Nick Kyprianou, senior vice-president of Home Trust Company in Toronto. "We'd turn them down if there's no ability to repay or their credit is so challenged."

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How you qualify
"There are a lot of people who can't get financing because their credit scores are below what the banks would accept," says Thomas Mah, a mortgage consultant with Mortgage Home in Vancouver. That's where second-tier or B-lenders come in.

These institutions -- including Home Trust, Xceed Mortgage Corporation and Firstline Access to name a few -- step in when the banks say no, reviewing applicants on an individual basis (major banks tend to use an electronic underwriting formula) and assigning higher-than-prime interest rates according to the borrower's risk level.

"Some borrowers fail to the see the benefits of dealing with private lenders because they are put off by their rates," says Chris Wyse, an independent mortgage specialist with First Choice Financial in Vancouver. "Private lenders offer an excellent way for borrowers to get in the market when conventional lenders won't permit it."

The key is the B-lenders' willingness to look at an applicant's entire financial situation. For example, a potential borrower may not have a substantial salary, but may rent a room to a student for extra income. Banks wouldn't count this, but many second-tier lenders will.

The self employed, contract workers or those paid by commission who lack the documentation required by banks are primary candidates, as are people who have good earnings potential but haven't been in their current jobs for the minimum time set out by traditional lenders.

Second-tier lenders also cater to those without an established credit history, such as recent immigrants or individuals with a history of credit problems, whether it's defaulting on bills or declaring bankruptcy. In most cases, the lender simply wants a reasonable explanation as to why the credit went bad.

Finding a lender
"There are lots of private lenders and they target a range of borrowing profiles," explains Wyse.

Lenders vary in the amount of risk they will take on. Most established B-lenders deal with candidates that are classified as near-prime -- in other words, the borrower represents minimal risk. "They have to have reasonable credit, not great credit," says Mah, adding that a handful of second-tier lenders will deal with anyone, regardless of their credit, as long as they put 25 percent down.

Some lenders only deal with residential first mortgages of up to 75 percent of the purchase price, while others offer second mortgages or are willing to lend 100 percent of the purchase price.

The array of lenders and products out there can seem overwhelming, but borrowers need not do the research themselves. Instead, you can use a mortgage broker who is familiar with various lenders. (To read more about mortgage brokers, check out Bankrate Canada's article, Should you use a mortgage broker?.)

In some cases, you may even get a referral from the bank that originally declined your mortgage application, the idea being that banks that take care of their customers this way are more likely to land business in the future, when the customer's credit is better.

B-lenders mean higher fees
Those borrowing outside of traditional banks can expect to pay anywhere between six and 16 percent interest, which is higher than the going rates at most of the big banks. For current mortgage rates, check out Bankrate Canada's mortgage rate home page.

Most second-tier lenders charge one or two percent above prime, while others that take on more risk increase rates accordingly.

For many borrowers, the added cost is a worthwhile investment. "The interest rates are higher, but there's a value in those higher rates," says Wyse. Namely, it gets you into a home of your own more quickly, so you're building equity instead of paying rent.

In addition, with prime rates being so low, more borrowers are willing to pay an extra percentage point or two more to get a foothold in a robust market. If the added interest means a borrower pays an extra $300 a month, that adds up to $3,600 a year. However, the increased value of the home over the long term will likely more than make up for the extra payment.

Second-tier lenders a short-term solution
Borrowers aren't locked in at a higher rate forever. Second-tier lenders know their niche in the borrowing pool. "These guys are very flexible, and they're usually happy to bail out after a year or two," says Wyse.

B-lenders typically arrange loans for one- to five-year terms, although in special circumstances, such as when someone is building a house and can't provide a letter of assessment, financing can be arranged for as little as a few months with an open mortgage.

On average, it takes people at least a year or two to fix or establish their credit, says Kyprianou. "They put in three years with us, then they can go back to a bank and get a full discounted mortgage once they've repaired what they need to repair."

According to estimates from Xceed, the near-prime market alone is about 10 percent of the total Canadian residential mortgage market, which the Canada Mortgage and Housing Corporation estimates to be about $550 billion. That's $55 billion worth of business, of which Xceed forecasts approximately $45 billion is still completely unserved.

That's a lot of potential homeowners who, despite the sea of second-tier lenders willing to help, aren't fishing for a mortgage for fear of hooking up with a shark.

Michelle Warren is a freelance writer in Toronto.

-- Posted: Feb. 7, 2005
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