When it comes to buying a home, one of the biggest hurdles many people face is securing a mortgage. For those who don’t have a large down payment or a traditional employment history, finding financing can be even more challenging.

Fortunately, in Canada, there are a variety of options available, including Mortgage Default Insurance (MDI) and Private Lenders. But what distinguishes them, and which is most appropriate for your circumstances? In this blog, we’ll break down the key differences between MDI and private lenders to help you make an informed decision.

What is Mortgage Default Insurance?

Mortgage Default Insurance is designed to protect lenders in case a borrower defaults on their mortgage. In Canada, MDI is required when the borrower is putting down less than 20% of the home’s purchase price. The insurance mitigates the lender’s risk by ensuring they will be compensated in the event of non-payment.

Eligibility for MDI:

For homeowners with a down payment of less than 20%, MDI is usually necessary. For those with smaller down payments, this insurance makes it possible to secure a mortgage through traditional financial institutions, such as banks and credit unions.

Benefits of MDI:

• Allows borrowers to purchase a home with a down payment as low as 5%.
• Helps avoid the need for private lenders, who may charge higher interest rates.
• Provides people with little money an easier way to become homeowners.

How Mortgage Default Insurance Works

The amount of the mortgage and the size of the down payment are two of the many variables that affect the cost of MDI. Usually included in the mortgage loan, the premium is paid down over time as part of your monthly installments.

Cost of MDI:
A percentage of the mortgage amount is used to compute the premium.  The lower your down payment, the higher the premium will be. For example, a 5% down payment will result in a higher premium than a 20% down payment.

Payment Options:
The premium can either be paid up front or rolled into the mortgage, making it more manageable for the borrower. It’s important to note that the MDI premium is non-refundable, even if you pay off your mortgage early.

What Are Private Lenders?

Private lenders are non-institutional lenders that offer mortgages outside of traditional financial institutions. These lenders can include individuals, private lending companies, and specialized mortgage funds.

Who Uses Private Lenders?
Private lenders are often used by individuals who do not meet the qualifications of traditional banks. This could be because of poor credit, unconventional income sources (like self-employment or freelance work), or other unique financial circumstances. Borrowers who are unable to secure financing through traditional means may turn to private lenders as an alternative.

How Private Lenders Differ from Traditional Lenders

Approval Process:
Traditional lenders, such as banks, typically require borrowers to have a strong credit history, a stable income, and a solid employment record. Private lenders, on the other hand, have more flexible approval criteria. They may be willing to overlook poor credit scores or unconventional income sources, making them a viable option for individuals who don’t meet the strict requirements of banks.

Flexibility:
Private lenders can offer more flexible terms compared to traditional lenders. They may be willing to negotiate on interest rates, repayment schedules, and loan amounts, depending on the borrower’s specific needs.

Interest Rates:
The biggest downside of working with private lenders is the cost. Since they take on more risk by offering loans to borrowers who may not qualify for traditional financing, private lenders typically charge higher interest rates. The rates can be significantly higher than those offered by banks and other financial institutions.

Mortgage Default Insurance vs. Private Lenders: A Comparison

Let’s compare Mortgage Default Insurance and Private Lenders to highlight the pros and cons of each option.

Eligibility and Requirements:

• MDI: Requires a minimum down payment of 5%, but is only available through traditional lenders.
• Private Lenders: No minimum down payment requirement, and more flexible approval criteria.

Costs:

• MDI: A premium is added to the mortgage based on the down payment and loan amount. The premium is usually rolled into the mortgage.
• Private Lenders: Higher interest rates than traditional banks, but no upfront premium costs.

Availability:

• MDI: Available through traditional financial institutions, but only for borrowers who meet certain criteria.
• Private Lenders: Available to borrowers who may not qualify for traditional financing, such as those with poor credit or irregular income sources.

When Should You Choose Mortgage Default Insurance?

MDI is ideal for homebuyers who:

• Have a down payment of less than 20% but meet the qualifications for traditional financing.
• Want to avoid the high-interest rates of private lenders while still qualifying for a mortgage.

First-Time Homebuyers:

Many first-time homebuyers find that MDI is their best option, as it allows them to purchase a home with a smaller down payment. MDI also helps ensure that they receive competitive interest rates.

When Should You Consider a Private Lender?

Private lenders are often the go-to option for individuals who:

• Have poor credit or irregular income.
• Need quick access to funding, as private lenders may approve loans more quickly than traditional banks.
• Are unable to meet the strict qualifications set by traditional financial institutions.

Which Option is Best for You?

• Choose MDI: If you have a small down payment but a strong financial background, MDI is likely your best option. It offers a longer repayment duration and more affordable interest rates.
• Choose a Private Lender: If you’re self-employed, have poor credit, or need a more flexible loan term, a private lender might be the better choice, despite the higher interest rates.

For homeowners who might not be eligible for conventional bank mortgages, Private Lenders and Mortgage Default Insurance both provide good alternatives. The choice between the two depends largely on your financial situation, including your credit history, down payment size, and how quickly you need to secure financing. Understanding these options thoroughly will help you make the best decision when it comes to homeownership.