An unusually detailed guide to building a mortgage startup in Canada
Getting tactical about the specifics on what you need to succeed as a mortgage lender in Canada
We are getting very niche today, folks. I expect that there might be at most a few dozen people for whom this post will be helpful—I’m writing this because I wish this had existed when we started Fraction and when it comes to starting a mortgage startup, especially in Canada, there’s basically no materials on the subject. We had to learn it all by trial and error and extracting the knowledge verbally through talking to industry insiders.
At Fraction, we started our mortgage lending fintech in British Columbia, expanded to Ontario next, and eventually got licensed in Alberta, Washington, Arizona, and Colorado. In total we did over $150M in lending across these different regions with the majority being in Canada.
If you think you have a handle on the actual nitty gritty and operations and are only wanting to learn how to get debt capital for your mortgage startup, check out my other blog post on that subject here. This post will be going over the regulatory environment, the specific players and tools you will need to work with in Canada, the different channels available to you for acquiring customers, and what your operations pipeline should roughly look like.
Now, I’m Canadian, and as is tradition for all Canadians, I have an inferiority complex when it comes to comparing ourselves to the U.S. One thing that I often hear Canadians bemoan is how much more business-unfriendly the government in Canada is compared to the United States. Broadly, I’d say, at least for for tech startups, that’s simply untrue—our labour laws are much more business friendly when you compare them to the bigger states like California and New York, and we have ridiculously generous tax credits for software engineering salaries (from the SR&ED program).
And for mortgage startups? Canada wins hands-down. The regulatory environment is orders of magnitude less onerous. This is probably because Canada didn’t have a 2008-style mortgage crisis and so (for better and also for worse) the laws have stayed closer to what the U.S. had prior to the mortgage meltdown.
If we had needed to launch Fraction in the U.S. first with our original shoestring budget, we simply wouldn’t have been able to get it off the ground. When we eventually launched our first U.S. state it costed us more than 10x the price to navigate all the legal and regulatory hurdles than it did when we launched in our first Canadian province.
This lack of regulation comes with a price—Canadian consumers can and do get screwed in ways that are simply illegal in the United States. For example, we had one person who came to Fraction who was looking to pay out their existing mortgage and use Fraction instead. When we read the fine print of their existing mortgage documents, we saw that they would have had to pay a prepayment penalty equal to the entire amount of interest that would accumulate throughout the term of the loan. They were in the first year of a 5 year mortgage, so they would have had to pay the 4 years of interest that hadn’t even happened yet to pay out their mortgage. Essentially, this made it impossible to escape the mortgage.
There are some regulations precluding large banks from having penalties like this, but there’s nothing stopping smaller lenders from doing it in Canada. In the U.S.—prepayment penalties are just straight up illegal and I think that’s the way it should be. There are a myriad of other laws such as anti-discrimination laws (called redlining laws) in the U.S. that Canada also simply doesn’t have.
That being said, I’m going to assume you are a good person and you want to do right by your future customers. In this case, Canada is an amazing place to launch and so let’s dive in to the mechanics of what that entails.
Mortgages are regulated on a province-by-province basis for startups
Unless you are a bank, if you are offering mortgages, you will be considered a private lender in Canada. I’m not going to cover bank regulations because that doesn’t really apply to startups.
So you want to start a private lender. What sort of mortgages do you want to offer? Traditional mortgage products with a better, modern UX a la Better.com or a unique spin on mortgages like Fraction? Or maybe you are wanting to do fractional shares in homes like Unison? The last category aren’t mortgages, and you will need to be covered under different regulations—probably real estate regulations.
So let’s say you are wanting to do mortgages. In order to operate as a private lender, you need to get licensed as a mortgage brokerage in every province you want to operate. In BC, you need to get licensed with the BCFSA, in Ontario, you need to get licensed with the FSRA (which people pronounce “fizzrah”). Each province has their own version of these regulators. My advice would be to start with one province and expand as you go.
Getting licensed
You need to be licensed before you can do any marketing efforts. We didn’t know this when we launched Fraction. When we launched our website to get signups for a waitlist, we were instantly reported to the provincial regulators for soliciting mortgage business without a license. Luckily for us, after some very scary email threads and phone calls, the regulators ended up gentle with us since we hadn’t actually conducted any business up to that point and simply told us to take down our website until we were licensed. So, first order of business is to get licensed.
In order to be licensed to operate as a mortgage brokerage, you need to have someone who personally holds a mortgage broker license and has been licensed as a mortgage broker for a number of years to register the mortgage brokerage under. The title of this person will vary depending on the province. In BC, this is called the Designated Individual, in Ontario it is called the Principal Broker. The years of experience requirement precludes you, the startup founder, from being that person unless you have already had a mortgage broker license for a number of years before launching your startup. So you need to find someone who is willing to hold the licenses and you will need to pay them for that. You might be able to pay them a small commission for every deal, or if you have cash in the bank from a fundraise, you might be able to pay them a fixed salary.
This licensed individual will assume risk for Bad Things Happening (if you commit fraud, for example), so you will have to convince them that you aren’t planning on getting up to trouble. At Fraction, we were industry outsiders, so we found our licensed individual by going down the list of mortgage brokers on Yelp and calling them one by one until we found someone who was interested in our idea and willing to take a bet on us.
As an aside, I do recommend you take the requisite course to become a mortgage broker in at least one province and become a licensed mortgage broker. I learned a ton when doing it myself, and assuming your startup becomes a success, you will eventually have enough years under your belt to become the Designated Individual or Principal Broker if needed.
Once you have found this person, you then need to register to get your license with the provincial regulator. This will involve sending in a bunch of personal information, doing criminal record checks, and filling out reams of paperwork. The time from applying for the license to being approved can be anywhere from 3 days (which happened for us!) to half a year (that also happened for us).
Note that if you have multiple business entities, if any of them are involved in originating or holding mortgages, each of those entities must be registered. So try to keep your org chart simple if you can and when you are setting up your business, don’t let your lawyers get too creative with multiple corporate entities—it will just make your life a hassle and will cost you more money for licensing.
Choosing your distribution channels
You can bifurcate the two main distribution strategies that you can use to find customers into mortgage brokers and direct to consumer advertising.
Direct to consumer channel
If you are building a modern user experience for mortgages, you will likely be focusing on direct to consumer. This means having a slick website, an amazing onboarding experience, automated underwriting, the works. This is an expensive build-out, but can pay off down the line. The main challenge is figuring out your marketing channels to keep your CAC down.
The benefit of selling mortgages is that they are such big-ticket items that usually you can support hundreds or even thousands of dollars in CAC. The downside is that all other mortgage lenders can also afford this, so prices can get very expensive for leads in the mortgage world. You really need to have some unique value proposition or lead magnet to give yourself an edge in this space. A good example of a great lead magnet are the rate sites that show different interest rates from different mortgage providers—those sites are actually owned by mortgage brokerages and act as a way for them to get new business.
Something to keep in mind is that any of your sales people that actively talk to customers will need to be licensed as mortgage brokers under your brokerage as well, so be mindful of that.
Mortgage broker channel
Mortgage brokers are professionals that everyday consumers can go to where they explain what they are looking for in a mortgage, and the mortgage broker will help that person find the best lender for their situation. Mortgage brokers are paid on a funded-deal basis, which means that they don’t get paid unless they help the consumer close on a mortgage.
As a lender, whether you can make inroads into the mortgage broker market very much depends on how much differentiation you have versus other lenders in your space.
If you are doing traditional mortgages, you might have challenges penetrating the broker market—what fundamentally do you have vs. all the other companies they are currently working with?
With mortgage brokers, you basically can differentiate yourself by:
Interest rate the consumer pays
Commission paid to the broker
Underwriting criteria and flexibility with that criteria
Broker support (answering their questions, having dedicated sales people focused on the broker channel)
Product features
Being amazing at any one of these dimensions can be enough to sway some brokers—you just have to find the right combination that works for you.
The commission to the broker can vary from anywhere from a fraction of a percentage point to multiple percentage points. (Sidebar: brokers generally talk about their compensation in basis points, aka bps, pronounced “bips”. 100bps = 1%).
You as the lender pay the broker their fee once the mortgage has funded. If you are selling traditional products, you likely can’t charge an upfront fee to the consumer (unless you have very different underwriting criteria which means you can serve a niche customer that would otherwise struggle to get approved for a mortgage) since most of the other mortgage lenders don’t have this fee. Depending on your funding sources, this can make it challenging to pay commissions to brokers in the first place.
If you have a unique product, the mortgage broker channel can be very appealing. If you aren’t competing against a wide array of other products they currently offer but instead have some combination of product features that nobody else offers that serves a segment of customers they otherwise might not be able to service, mortgage brokers are willing to listen to you and won’t be as compensation-sensitive.
The other benefit to having a unique product is that you are more likely to be able to charge an upfront fee to the consumer (which you can roll into the loan amount), which will help your early revenue numbers and be able to pay broker commissions.
The broker channel can be very lucrative, it has predictable costs, and you only pay if your deal closes. If you think you can succeed in the broker channel, you should go after it.
It will involve lots of on-the-ground business development managers to nurture those broker relationships, so there is a lag time to getting going, but it is likely to pay dividends in the future without you having to outlay significant amounts of marketing dollars. One thing to note is that your business development managers will also need to be licensed mortgage brokers, which does limit your candidate pool quite significantly.
Integrating with existing mortgage systems
Broker channel
If you want to receive deals from mortgage brokers, and you are a technical founder, your first inclination is probably to build some amazing dashboard for brokers to submit deals, track their deals, submit additional documents, etc.
Don’t do that. At least, not to start.
Most mortgage brokers are part of very large broker networks such as DLC, M3, etc. These groups require their brokers to submit deals through their own tools. These systems are likely one of:
Filogix Expert (the incumbent)
Newton Velocity (the fast follower)
Finmo (a newer upstart)
You are very unlikely to be able to directly integrate with Filogix—I was never able to even get ahold of someone that worked there. My recommendation is to use a tool like Newton Velocity or Lendesk which have lender products with integrations into all these submission tools for you to receive applications in. Newton has an (XML-based) API as well, so if you want to layer in your own systems on the back end, that could be a good one to go with.
Direct channel
If you are doing deals direct to consumer, you will need to at least integrate with credit bureaus to pull credit. The mortgage broker submission tools will usually include the credit report, so you don’t necessarily need it if you only receive deals through brokers (although you may still need to pull reports yourself depending on your underwriting criteria). The two main credit bureaus in Canada are TransUnion and Equifax—Experian does not operate in Canada. Integrating with the bureaus is a very slow process, so I’d recommend starting with a third-party that sits on top of the credit bureaus that can pull credit reports on your behalf.
If you want to work directly with the bureaus, which you might want to do in order to get a deeper level of report granularity for soft pulls or to get better volume-based pricing, you should expect it to take at minimum three months and potentially the better part of a year to get access. You will also need to get creative in how you get a hold of someone at these companies, I’d suggest finding an account executive on LinkedIn and reaching out directly to them. You need a champion inside the organization to push for you.
Getting your mortgage documents created
You will need to hire a law firm to create your mortgage documents. They may also need to register some parts of the documents with the provincial title registries. This can cost anywhere from thousands to the low hundreds of thousands of dollars depending on the novelty and complexity of your documents.
Setting up your operations
Your funding pipeline, at a very high level, will look something like the following. It doesn’t always have to be in this exact order, but these are the general steps:
Application comes in from either a direct customer submission or a mortgage broker
You do an initial check of the application (called underwriting the file) to see if it matches your lending criteria. This lending criteria will be agreed upon in advance by you and any sources of mortgage capital you might have.
If the application matches your criteria, you send back a “commitment letter” which outlines the terms of the mortgage for them to sign. This letter is not a guarantee that you will fund, as that still depends on the rest of the application process going smoothly, but it will often include an interest rate lock where you as the lender will lock in the advertised rate for the borrower in case your interest rates go up in the meantime.
You perform Know Your Customer (KYC) checks to verify that the client is who they say they are. This will usually involve looking at their government issued ID and making sure it matches them. If you are a purely digital operation, there are lots of KYC providers to choose from. At Fraction, we used Persona to do this.
You collect all other documentation you need from the client. This might involve paystubs, tax receipts, bank statements, etc. to verify that they have sufficient income to support the mortgage, that they have sufficient assets to pay the downpayment, and so on.
You get an appraisal done on the home the client is looking to purchase (or their existing home if they are doing a refinance). An appraisal isn’t always done by mortgage lenders, but it usually is. The appraisal can either be automated or it can be an in-person appraisal where the appraiser physically goes to the house. The appraiser then provides you and the homeowner/prospective buyer a report with the estimated home value and a description of the methodology and things they took into consideration to arrive at that value. The customer pays for the appraisal, it will often cost somewhere between $350-$1000 depending on the region and type of home.
You may also order an inspection on the home. This isn’t done as often as appraisals, but some lenders do require it. Savvy home buyers will often want to do an inspection anyways to make sure there’s nothing wrong with the house they are hoping to buy. The customer also pays for this, and can be a similar price to an appraisal.
Your underwriting team gives the final thumbs up. You send out final approval to the customer/their broker. You may want to send them the mortgage documents to review at this stage, although they will need to actually sign the documents with a notary or a lawyer present.
They go to a notary or lawyer and sign the mortgage documents. The lawyer/notary then sends you the signed documents.
You then send all the documents over to a different real estate law firm to register the charge to the provincial title registries in the final part of the process called conveyancing. Once you scale up, you may end up bringing conveyancing in-house, but you likely won’t do that to start with that. You likely will also send the funds to the conveyancer who will hold it in escrow and then deliver the funds (to the customer if it’s a refinance or to the seller if it’s a purchase) once the charge has been successfully registered on title.
By this point, once you’ve set all this up, you are ready to launch your mortgage lending startup!
There’s a lot of steps there, lots of information to gather, and lots of points of friction for the customer and/or their broker. Part of the fun part of a mortgage startup is figuring out how to streamline and automate that process, and you can spend years tweaking and tuning it all. One of the big things at Fraction that we were focused on was reducing the time it took to fund a deal. The industry average is over a month, so there’s lots of room for improvement and startups are well-positioned to execute on that.
Starting a mortgage business is much more complicated than many other types of startups, so you have to have real conviction in what you are doing and be willing to dedicate quite a lot of time to getting it off the ground. If you get it going though, it can be a great business and hopefully this guide helps you get started!