Getting Mortgage Approval After the Big Banks Say No
(Eight-minute read time)
Navigating the mortgage landscape can be daunting, especially with the strict criteria set by Canada's Big Five Banks: RBC, TD, Scotiabank, BMO, and CIBC. This can be particularly challenging for self-employed individuals and those with non-traditional income sources.
In this article, we explore another route for securing a mortgage: Alternative Lenders, who provide a more accommodating approach for individuals who need customized solutions. Specifically, we’ll discuss who Alternative Lenders are, their benefits, their risks, and the next steps you can take to get closer to your mortgage approval.
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Who Are Alternative Lenders?
Alternative Lenders offer mortgage solutions outside the traditional banking sector. Alternative Lenders often cater to borrowers who might not meet the strict criteria of major banks, such as self-employed individuals or those with non-traditional income sources. While Alternative Lenders provide flexible mortgage options, they may come with higher interest rates and fees to offset the increased risk.
It is also important to note that Alternative Lenders are not Private Lenders. Alternative Lenders have more rules associated, while Private Lenders can be an organization, a group or an individual not associated with a financial institution.
Common Reasons Big Banks Say No
High Debt-to-Income Ratio: Your debt-to-income (DTI) ratio measures the percentage of your gross monthly income that goes toward paying debts. Traditional banks typically prefer borrowers with lower DTI ratios, as this indicates a lower risk of defaulting on the mortgage.
Insufficient Income Documentation: Traditional banks require proof of stable and sufficient income to ensure that you can meet your monthly mortgage obligations. This can create challenges for self-employed individuals.
Credit Event: A temporary change in circumstances that affects credit score or payment history can signal to lenders that you might be a risky borrower, leading to rejection. Often, this can occur with job loss, business growing pains, or divorce.
Why Choose Alternative Lenders?
Flexible Criteria: Alternative Lenders often accept various income sources, including self-employment and commission-based earnings. They are also more likely to overlook credit events that might disqualify an applicant at a traditional bank.
Quick Approvals: Alternative Lenders often have faster approval processes, which can be crucial for clients needing quick financing or those facing time-sensitive opportunities.
Tailored Solutions: These Lenders offer customized mortgage products designed to meet the unique needs of their clients, such as longer amortization periods or higher loan-to-value ratios.
Higher Risk Tolerance: They are willing to take on higher-risk borrowers because they have more lenient debt-to-income (DTI) ratio requirements. This is beneficial for clients who have recently experienced a credit event or have an unconventional financial profile.
Working with a Good Mortgage Broker Can Help You Save Money, Time, and Stress
Learn more in our article: Good vs Bad: How to Recognize a Great Mortgage Broker from the Rest
Benefits of Alternative Lenders
For some homebuyers, securing a mortgage can be challenging, especially with traditional banks. However, Alternative Lenders provide benefits that can make the approval process smoother and more accessible. Below is a detailed explanation of the advantages of using Alternative Lenders.
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Varied Income Sources: Alternative lenders understand that not all income comes from traditional salaried positions. They are more open to accepting different types of income, including self-employment, freelance work, and contract-based earnings.
Credit Event: If you experienced a recent credit event, alternative lenders may still be willing to work with you. They often have a higher risk tolerance compared to traditional lenders.
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Streamlined Application: These lenders typically have fewer hurdles when approving loans, making it easier for borrowers to submit their applications and receive a response. However, alternative lenders still require a substantial amount of documentation, especially for self-employed individuals. Proper preparation and professional assistance, like working with a mortgage broker, can help borrowers effectively navigate these requirements.
Quick Turnaround: Unlike traditional banks that may take weeks to approve a mortgage, alternative lenders can often provide approvals in days. This quick turnaround time is especially beneficial for homebuyers looking to move quickly in a competitive real estate market.
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Customized Mortgage Products: Unlike traditional banks, which often have rigid mortgage offerings, alternative lenders provide a range of tailored mortgage products to meet the specific needs of their clients. This means they can design mortgage solutions that better align with the borrower's financial situation, goals, and timeline. For instance, they might offer longer amortization periods, which can lower monthly payments, making the mortgage more manageable for those with irregular income or higher expenses.
Specialized Programs: Alternative lenders can have specialized programs that can help provide clients with more comprehensive financial solutions for their mortgages.
Responsive Adjustments: Because alternative lenders are smaller than large banks, they can quickly adjust their products and services to respond to changes in the market or individual client needs.
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Lenient Debt-to-Income Ratios: Traditional banks usually have strict debt-to-income (DTI) ratio requirements, which can disqualify some potential borrowers. Alternative lenders, on the other hand, are more lenient with these ratios. They may approve mortgages for clients with higher DTI ratios, recognizing that the borrower can manage their payments despite carrying more debt. This approach is particularly beneficial for individuals who have significant but manageable debt, such as student or business loans.
Willingness to Accept Unconventional Profiles: Alternative lenders are often more open to working with clients who have non-traditional financial profiles. Alternative lenders focus more on the borrower’s current financial situation and their ability to make future payments rather than just their past financial history.
Higher Loan-to-Value Ratios: Many alternative lenders are willing to approve mortgages with higher loan-to-value (LTV) ratios. This means they are comfortable lending a higher percentage of the property's value compared to traditional banks. This is particularly useful for clients who may not have a large down payment but have a strong income or other factors that demonstrate their ability to repay the loan.
Is Getting a Pre-Approval Worth It?
Read our article to learn more: Do I Need to Get a Mortgage Pre-Approval?
The Downsides to Alternative Mortgage Lenders
While Alternative Lenders offer several benefits, it's important to be aware of the associated downsides:
Higher Interest Rates: Alternative Lenders often charge higher interest rates to compensate for the increased risk of lending to individuals with less conventional financial profiles. This means you may end up paying more in interest over the life of the loan.
Shorter Loan Terms: Alternative Lenders might offer shorter loan terms, which can impact your monthly payments and the overall cost of the loan. Shorter terms can lead to higher monthly payments, so it's important to ensure you can afford these payments comfortably. Additionally, in some cases, the Alternative Lender may not renew once the term is complete. Overall, terms for Alternative Lending are a lot more strict, it’s important to review your loan agreement with your mortgage broker.
Additional Fees: Be aware of common fees associated with Alternative Lending, such as application fees and lender fees. These fees can add up quickly, so it's important to factor these fees in when comparing lenders.
Higher Penalties: Alternative Lenders often impose prepayment penalties to protect their expected interest income over the loan term. There’s also the possibility of additional penalties, so make sure you understand the terms and conditions before finalizing a loan agreement.
Lack of Flexibility Once Mortgage is Set: Due to the higher penalties associated with Alternative Lenders, borrowers often have restricted options to make financial adjustments on their mortgages.
Roger's Path to Homeownership Through Alternative Lending
Meet Roger, an owner of a local construction company in Guelph. Over the past year, his company has generated a revenue of $200,000. However, Roger has only paid himself a salary of $50,000. This decision, while beneficial for tax purposes, has placed him in a challenging situation when it comes to securing a traditional mortgage for the home he dreams of buying.
The Mortgage Dilemma
Roger has his sights set on a house priced at $500,000. He hopes to put down $104,000 as down payment. Under traditional mortgage lending criteria, banks typically assess the borrower's income to determine eligibility and loan amounts. Given that Roger's reported income is only $50,000, traditional lenders view him as a higher risk and would likely offer him a mortgage of around $200,000. This would leave him with a significant funding gap for his home purchase.
Traditional Mortgage:
Home Price: $500,000
Down Payment: $104,000
Lender Fee: $0
Traditional Mortgage Amount: $396,000
Estimated Monthly Payment (at 5% interest for 5 years): approximately $2,113
Total Interest Paid Over 5 Years: approximately $38,630
If Roger decides to increase his salary to qualify for a traditional mortgage, his monthly payment would be $2,113 and the total interest over 5 years would total to $38,630.
The Alternative Lending Solution
Fortunately, Roger’s mortgage broker informed him that he could get a mortgage with an alternative lender since alternative lenders often consider different income sources, including retained earnings from his business, which allows them to look beyond just his salary.
With the alternative mortgage option, Roger can leverage his business income more effectively. Even though the interest rates are typically higher, he qualifies for a loan based on his company’s overall earnings. This enables him to secure a mortgage amount that better aligns with his home-buying goals.
Alternative Mortgage:
Home Price: $500,000
Down Payment: $104,000
Lender Fee: $3,960 (1% of base loan at $396,000)
Alternative Mortgage Amount: $399,960
Estimated Monthly Payment (at 6% interest for 5 years): approximately $2,355
Total Interest Paid Over 5 Years: approximately $46,371
If Roger decides to get an alternative mortgage, his monthly payment would be $2,355, and the total interest over 5 years would total to $46,371.
Tax Comparison
In the context of Roger’s financial situation, understanding the tax implications of his salary choices is crucial for evaluating his overall savings and financial strategy. By paying himself a lower salary of $50,000 instead of the full $200,000, Roger significantly reduces his tax burden, which has a long-term impact on his financial health.
If Roger Pays Himself $50,000:
Annual Income Tax: Approximately $11,917
Total Income Tax After 5 Years: $59,585
If Roger Pays Himself $200,000:
Annual Income Tax: Approximately $71,513
Total Income Tax After 5 Years: $357,565
By opting for the lower salary, Roger saves $297,980 in taxes over 5 years.
Total Costs
While the alternative mortgage leads to a higher interest payment over 5 years compared to a traditional mortgage, Roger’s financial strategy will result in a lower total costs when factoring in tax savings:
Total Costs Over 5 Years (Alternative Mortgage + Income Taxes at $50,000 salary):
Total Fees & Interest on Mortgage: $50,331
Total Income Tax: $59,585
Combined Total: $109,916
Total Costs Over 5 Years (Traditional Mortgage + Income Taxes at $200,000 salary):
Total Fees & Interest on Mortgage: $38,630
Total Income Tax: $357,565
Combined Total: $396,195
Conclusion: It’s a Numbers Game
Ultimately, while Roger's alternative mortgage comes with higher interest costs, the tax savings from maintaining a lower salary result in a more favorable long-term financial outcome, a difference of $286,279. Over 5 years, Roger stands to save significantly more by managing his salary strategically, thereby allowing him to invest in homeownership without compromising his financial stability.
How to Choose the Right Mortgage Lender for You
Choosing the right lender requires careful consideration and research. Here's how you can navigate this process to find the best fit for your financial needs:
Research and Compare
Start by evaluating key factors such as interest rates, fees, and loan terms. While Alternative Lenders might offer more flexibility, they can also have higher interest rates than traditional banks. Understanding the full cost of a loan, including any hidden fees, is crucial.
Additionally, reading reviews and testimonials from other clients can provide valuable insights into a lender's reliability and customer service. Look for feedback on the lender's responsiveness, transparency, and willingness to work with clients facing unique financial situations. This information can guide you in making an informed decision.
Seek Professional Advice
Working with a mortgage broker can simplify the process of ensuring you find the right lender for you. Brokers have access to a wide range of lending options and can help match you with a lender that suits your needs. They can also negotiate better terms on your behalf, potentially saving you money in the long run.
Mortgage brokers are especially useful in navigating the complexities of Alternative Lending, as they can provide insights into which lenders are more flexible with their criteria and which offer competitive rates.
Conclusion
Navigating the process of getting a mortgage can be particularly challenging for those with unique financial profiles. Thankfully, Alternative Lenders offer a viable solution for many prospective homebuyers seeking mortgage approval.
To learn more about how Alternative Lenders can support your mortgage plans, contact us today for a personalized consultation at no cost or commitment.
FAQ About Alternative Lenders
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Alternative Lenders are financial institutions that offer mortgage solutions outside of the traditional banking sector. They cater to borrowers who may not meet the strict criteria of major banks, such as self-employed individuals, or those with non-traditional income sources.
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Alternative Lenders offer more flexible criteria, including accepting varied income sources like self-employment and commission-based earnings. They also have quicker approval processes and tailored solutions, such as longer amortization periods and higher loan-to-value ratios. This flexibility is particularly beneficial for borrowers with unconventional financial profiles.
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Traditional Banks often reject mortgage applications if there is history of a credit event, insufficient income documentation, or a high debt-to-income ratio. These factors signal higher risk to the bank, making them less likely to approve the mortgage.
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Flexible Criteria: They accept various income types.
Quick Approvals: Faster approval processes can be crucial for time-sensitive financing needs.
Tailored Solutions: Customized mortgage products to meet the unique needs of borrowers.
Higher Risk Tolerance: Willingness to take on borrowers with higher risk profiles, such as those with higher debt-to-income ratios.
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Higher Interest Rates: To offset the increased risk, Alternative Lenders often charge higher interest rates.
Shorter Loan Terms: This can lead to higher monthly payments, which may impact affordability.
Additional Fees: Expect to encounter application fees, lender fees, and potentially high penalties for early repayment.
Lack of Flexibility: Once the mortgage is set, there may be limited options for making adjustments due to higher penalties.
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Start by researching and comparing key factors like interest rates, fees, and loan terms. Reading reviews and testimonials can also provide insights into a lender's customer service and reliability. Working with a mortgage broker can simplify the process, as they have access to a wide range of lenders and can negotiate better terms on your behalf.
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Yes, Alternative Lenders typically have faster approval processes because they are more flexible with their criteria. This can be beneficial for borrowers who need quick financing.
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Consider the full cost of the loan, including interest rates, fees, and any potential penalties. It’s also important to understand the lender's criteria and how they align with your financial situation. Speaking with a mortgage broker can help you navigate these factors effectively.
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