Navigate Alt-Lending: A Lender Due Diligence Checklist for Brokers
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January 24, 2023 |
Navigate Alt-Lending: A Lender Due Diligence Checklist for Brokers
Take the guesswork out of choosing alternative lenders as a mortgage broker with this handy due diligence checklist!
Here’s what you need to know:
Why it's important to know what to look for when selecting an alternative or private lender.
What factors to consider when looking at a lender's reputation and track record, e.g. are they members of organizations such as CAMLA, CMBA, and MPC.
The essential factors include the lender's prepayment, default, and renewal policies.
Download your free Due Diligence Checklist Here.
As a mortgage broker in Canada, you play an essential role in connecting borrowers with lenders. In today's market, alternative and private lenders are becoming increasingly popular. However, not all alternative and private lenders are created equal, and you need to know what to look for when choosing which lenders to work with. I’ve touched on this topic in the CMP article entitled, “What should brokers keep in mind when choosing an alt-lender?” which you can read here.
Lender Reputation and Industry Organizations
Several crucial factors to consider are the lender's reputation, track record, and whether they are a member of industry organizations such as CAMLA, CMBA, MPC, etc. Such industry organizations have codes of conduct and ethical guidelines that the members must abide by. These guidelines help ensure that the lenders operate ethically and professionally; otherwise, they risk losing their membership. Additionally, industry organizations may provide their members with further training and resources. Which generally focus on best practices and compliance with laws and regulations, which can help the lender to maintain high standards of conduct.
Aside from checking if they are part of various industry organizations, you can read their reviews online. The best reviews come from borrowers because they are the end user of the financing. If your clients are happy, you're more likely to receive referrals.
As a mortgage broker, your task is to find the best deal for your client and their circumstances. It is important to remember that the interest rate is not the only factor to consider, as prepayment charges and other fees can substantially increase borrowing costs. This presents an opportunity to provide valuable education on prepayment penalties to your clients, giving you an edge in the competitive mortgage market.
Preparing for Prepayment Penalties
It is not uncommon for borrowers to pay off their loans early, especially in private and alternative lending situations. This is because borrowers often use the funds to get them through a transitional period. Examples of these situations include:
Closing on a rental or investment property before arranging bank financing.
Taking out equity from their existing home to purchase another home.
Consolidating debts to increase discretionary funds available.
Using home equity to invest in their business.
These use cases are several of many. The commonality is that the borrowers tend only to have short-term needs. Typical term lengths range from 6 months to 36 months. Even with bank financing, many borrowers break their terms early. Therefore, reviewing the lender's prepayment policy and explaining it to your clients is essential.
Aside from understanding how the prepayment penalty is calculated, it is vital to understand the notice a borrower needs to provide the lender before being able to pay off their mortgage. Don't assume all notice periods work the same way. For example, even some bank lenders require ten days' notice to produce a payout statement. Failure by the borrower to provide enough notice may delay the borrower's ability to pay off the mortgage because they can't receive a payout statement. Alternatively, the lender may add an interest per diem to the mortgage balance to compensate them for failing to receive adequate notice. This can add up quickly. For example, on a $500,000 mortgage at 8% interest, the per diem is approximately $110 a day, which is $770 for seven days, $1,650 for fifteen days, and $3,300 for thirty days.
Alternative and private lenders may offer flexible terms such as open, partially open, closed with prepayment privileges, and fully closed, which can match the borrower's needs and save them thousands of dollars. However, paying attention to the lender's payout penalties and policies is crucial when considering these options. The questions to ask are straightforward:
How much are the lender’s prepayment penalties?
How are the lender’s prepayment penalties calculated?
How much notice does the lender require for the loan to be paid out?
Does this notice period include the time it takes for the lender to produce a payout statement?
How does the borrower provide the lender with notice, e.g. does a payout request need to come from the borrower’s lawyer or notary?
Borrowers often prioritize obtaining the lowest interest rate, but it's important for them to also consider the costs associated with paying off their mortgage. As a mortgage broker, you can demonstrate your value by guiding them through the process and helping them save money. One useful strategy is to schedule important dates for your clients in your CRM system.
Understanding Default Policies and Fees
It is important to understand a lender’s policy regarding missed payments. These policies are commonly found in the “Events of Default” section of the lender’s mortgage terms. As a reminder, a default under a mortgage means the borrower has breached one of the conditions of the loan. Aside from the commonly known default resulting from missing mortgage payments, be aware that a default can be caused by a borrower having unpaid property taxes, lapsed property insurance, etc.
Most lenders, including alternative, private, and bank lenders, will have standard administrative fees whenever a borrower defaults on the mortgage. Before having your client commit to a lender, it is important to review these charges, as they can range from one lender to another. Ideally, your client does not default, but if they do, it will likely be a missed payment due to non-sufficient funds, so this is one of the key items to focus on because these fees can range from $95 to $200+.
Lenders don’t want their loans in default, so they will actively work to remedy that default. Therefore, you and your client must understand the lender’s collection policy and mortgage enforcement process. You will want to know the timeline, the steps a lender will take in the event of a default, and how administrative fees will be applied. In medicine, the saying “an ounce of prevention is worth a pound of cure” also applies to mortgages. It is important that you can communicate with the borrower the potential consequences of defaulting on the loan to help them understand the importance of keeping their payments current. This can help your clients make more informed decisions and protect your reputation as a broker with your client and the lender. Example questions you can ask the lender are:
How much does the lender charge for a missed payment?
Can you send me a list of the lender’s standard service charges?
How willing is the lender to work with borrowers who have difficulties?
How fast will the lender demand a mortgage if there is a default?
Administrative fees or service fees help deter borrowers from defaulting. If your client misses a mortgage payment and defaults, higher service fees will drive up the borrower’s cost of borrowing. Since many lenders' service fees are set in stone, it’s best to request a list of standard service fees upfront before obtaining a commitment if you have not worked with a particular lender before.
Knowing the answers to these questions can help you advise your client accordingly and be realistic. Keep in mind that where the borrower is at a high loan-to-value (LTV), there is also a higher risk of loss if there is a default, which could result in the lender being more proactive about enforcing their mortgage to protect their interests.
Lender's Renewal Policy and its Impact on Borrowers
Additionally, you will want to understand their renewal process clearly. This means asking your lender about interest rate increases at renewal over and above market increases, i.e. prime rate increases, renewal fees, and the likelihood of renewal. Many lenders will be happy to renew borrowers so long as the borrower is current and there have been no material risks in the market - Read below about funding sources to learn how they can impact renewals. Unwelcome surprises such as an interest rate increase, renewal fees, or a non-renewal could lead to an unsatisfied client. Four key questions are:
How does the lender price deals at renewal?
How much does the lender charge for renewal fees, if any?
What are the reasons why the lender would not renew a loan?
Who manages the renewals, and how and when are the notices sent out to borrowers?
Is there an automatic renewal policy the borrower should be aware of?
By understanding these factors, you can better advise your clients on the best options for their specific needs and ensure that they know about potential costs at the time of renewal and the likelihood of the lender renewing their loan. As a mortgage broker, it is important to know the lender's renewal policy to ensure that you can provide the best service for your clients.
It is also important to know if the lender has an automatic renewal or a rollover policy in the terms of their mortgage. As the names suggest, automatic renewals enable the lender to renew the borrower automatically into a new term. Some lenders’ renewal policies require that the borrower responds to the lender before the maturity date. Automatic renewals can lead to higher borrowing costs, so it is critical that the borrower communicates with you and their lender before maturity. Many lenders with auto-renewal clauses will automatically renew the borrower into an open term, often at a higher interest rate, but the borrower gets the benefit of being able to pay their mortgage out without penalty. Even if the borrower renews with their existing lender, they may have to pay a per diem at the higher open interest rate. Renewal offers will typically include the date borrowers need to respond to lenders. It is extremely important that they are aware of this date.
As a precaution, it is important to inform the borrower that if they do not plan to renew their loan with their current lender, they must repay the loan in full on or before the maturity date. Failure to do so may result in the lender demanding repayment, which can lead to legal action against the borrower.
Funding Sources for Alternative and Private Lenders
Another important aspect to consider is the lender's funding sources. Mortgage Investment Entities (MIEs), including Mortgage Investment Corporations (MICs), raise money through investors and may have access to bank credit facilities. Having access to diversified funding sources allows MIEs to offer more competitive rates than individual private lenders. In contrast, individual private lenders lend their own money directly and may rely heavily on interest income, fees, and mortgage repayments for liquidity, resulting in higher pricing. Some questions to ask are:
Where does the lender source their funds from?
Are the funds sourced from institutional investors, retail investors, or private individuals?
Has the lender ever had to cancel commitments due to a lack of funds?
Has the lender ever experienced a high volume of investors withdrawing their investments from your fund (ie high redemptions)?
Understanding the answers to these questions enables you, as a broker, to better explain the associated risk of working with certain lenders to your client. A lender’s liquidity affects not only their pricing but their ability to fund commitments and offer borrowers renewals. There might be a greater risk of this when an individual private lender is matched with an individual deal. Regardless of the type of lender, if they want their money back at maturity, you and the borrower will need to find a lender willing to refinance the loan, which could result in added costs, so it is important to understand the lender's access to funding.
Good Governance is Good For You and Your Client
Good governance is important for any lender, including alternative lenders, because it helps the lender operate ethically and transparently. One way lenders achieve this is by having an advisory committee. This committee is usually made up of independent industry experts and guides the lender on topics such as risk management, compliance, and overall strategic direction. You will want to understand if the lenders you work with have such a committee as part of their governance structure.
A lender with an advisory committee benefits you as a mortgage broker because the lender has an independent party to challenge their decisions and policies. The expertise of the advisory committee members can be leveraged to identify potential risks and opportunities, helping the lender to stay up-to-date on industry best practices and to make better decisions, which can improve the probability of the lender having improved financial stability and ethical practices within the lender. Imagine, as a broker, if you had to provide a group of experts with updates on your business and receive feedback from them. Through that process, you would likely discover areas of risk and opportunities. It is straightforward to determine if a lender has an advisory committee to help guide their business. You just have to ask. They likely don't have one if they ask what an advisory committee is.
Protecting Your Client’s Data and Your Reputation
As a mortgage broker, it's important to ensure the lenders you work with keep private information, like personal and financial details, safe. One way to do this is to ask about their cyber security plan. This is a plan to protect private information from bad people who want to steal it. When you ask about the plan, here are some important questions to ask:
What steps do they take to protect private information from bad people online?
How does the lender detect and respond to cyber threats?
How does the lender regularly test and update its cybersecurity systems?
Does the lender have an incident response plan in place in case of a data breach?
How often do they update their cyber security plan to make sure it's still working?
How do they get rid of private information when it's not needed anymore?
By asking these questions, you can better understand how the lender protects sensitive information and if they direct efforts towards protecting borrowers' personal and financial data.
Being a mortgage broker in Canada's alternative lending market requires a deep understanding of different lenders and their policies. By being aware of a lender's reputation, prepayment penalties, default policies, renewal process, funding sources, and any industry organizations they may be part of, you can make informed recommendations to your clients and ensure that they are getting the best deal for their specific needs.
To help you navigate this process, we have created a downloadable checklist of critical factors to consider when choosing an alternative lender. To download the checklist, click the link below.
Disclaimer:This article was written for licensed mortgage agents or mortgage brokers. Neighbourhood Holdings does not guarantee any results from using this content. It is your responsibility to do your own research, consult, and obtain professional legal, financial, or other help that you may need for your use or situation.Author Profile
Jared Stanley is the Senior Director of Originations at Neighbourhood Holdings. He has been in the industry for nearly 15 years. In 2015, Jared was awarded Underwriter of the Year by the Canadian Association of Accredited Mortgage Professionals. He is also a motorcyclist and dog lover.