Ever since the introduction of the stricter mortgage stress test, many Canadians have struggled to get traditional financing when buying a home or getting a second mortgage. As a result, more and more are turning to private mortgage lenders, which nearly always come at a much higher interest rate.

Private mortgage lenders in Canada can be anything from a large corporation with hundreds of employees to a single investor, but most operate in the same way. They don’t have as stringent requirements for a mortgage as banks do because they don’t have to give the stress test. Unlike banks, private mortgage lenders aren’t federally regulated.

It's important to note that not all private mortgage lenders in Canada are predatory. They are able to navigate certain laws because, unlike banks, they do not accept deposits, which is why banks are subject to strict regulation. These lenders operate using their own capital or that of their investors.

However, it's true that the interest rates offered by private mortgage lenders are generally higher than those of banks. For instance, the most competitive 5-year fixed rate for a new mortgage is currently 2.64%, whereas rates from private lenders begin at 7% and can escalate to as much as 15% for a second mortgage.

The real issue with private mortgage lenders is not just their elevated interest rates compared to banks, but the increasing reliance on them by homebuyers and homeowners. With many Canadians unable to meet the criteria for a conventional mortgage under the new stress test regulations, turning to private lenders becomes the sole alternative. This is disadvantageous for borrowers, who are then subjected to higher interest payments for essentially the same mortgage product.

Those who already have mortgages are also impacted, albeit to a lesser degree. The new regulations mandate that you must qualify again for your mortgage at each renewal period, as well as at the initial purchase, unless you choose to renew with your current lender. This grants significant leverage to your existing mortgage provider, making it challenging for you to compare rates and secure the best deal if you cannot satisfy the stress test requirements.

Moreover, the new rules complicate even straightforward actions like refinancing your mortgage, despite having substantial equity. The stress test, on average, diminishes your purchasing power by 20%, affecting even current homeowners.

Private lenders bypass these stringent rules, which simplifies the approval process, but this convenience comes at a cost. Opting for a private mortgage should be considered for short-term objectives, such as bridging a brief financial gap or averting a power of sale, with the intention of transitioning to a traditional bank or monoline lender once the circumstances improve.