Todays’ Ontario Real Estate market may be described as inaccessible with its high property prices and even higher mortgage interest rates. Many people are turning to inter-generational living situations or may require the help of another related party to finance their purchase and to be able to sustain their living arrangements. The most common situation is to involve the purchasers’ parents to assist with financing. Often, especially when it comes to young first time buyers, the children may rely on their parents for financial assistance with their downpayment or/and securing a mortgage for the desired property. However, parents may not be the only ones to act as co-borrowers, in many cases it may be a sibling, or spouse or even a friend. It is important to note that the bank will require a co-borrower to be noted on the title of the said property. Therefore, co-borrower will also have to become a co-owner. As a co-owner of the property, the individual has the same rights as the other co-owner. Therefore, it is vital to pick a person(s) who you trust as well as protect yourself from a legal perspective. In this article we will discuss the benefits and challenges associated with co-borrowing to finance your real estate purchase in Ontario, tips for establishing a successful co-borrowing relationship and consequences when co-borrowing relationships comes to an end.
Advantages to co-borrowing relationship
One of the main advantages of co-borrowing and co-ownership is the fact that with additional people participating in the purchase, the buyer can afford certain property and may even be able to qualify for a better rate at the bank if co-borrower has a pre-existing relationship with that banking institution. While co-borrowing allows the purchaser to qualify for financing and to buy the property of their dreams, there are quite a few challenges that, if not handled right, may become a nightmare both for the buyer as well as co-borrower.
In the instance where parents are helping their buyer child, who is single and over the age of 18, by acting as co-borrowers for the purpose of buying a property, there are several potential challenges that both parents and the child buyer needs to be aware of. Once the parents become co-borrowers and as a result co-owners, the liability is shared between the parents and the buyer child. For example, should the buyer child stop making mortgage payments, the parents are equally responsible for the payments and all the benefits/challenges that come with home ownership.
Furthermore, should parents already own property of their own, the newly acquired property that they are helping their child with by acting as co-borrowers would be considered their investment property if they are not residing with their child. Once the property is sold, the buyer child and the parents are liable for capital gain tax, unless both resided in the property as their primary residence. Where the child buyer resided at the property, he/she would not be liable for capital gain tax. But the burden of capital gain would fall onto the parents, who are not residing at the property in question and have another property designated as their primary residence. Therefore, the parents who are choosing to become co-borrowers should consider the financial burden such as mortgage payments, property taxes, maintenance fees and capital gain tax that will be placed on them as a result.
To minimize the tax implication for the co-borrowing parent, your real estate lawyer may suggest changing the percentage of ownership allocation to the buyer child and the parents. For example, the buyer child could be registered as 99% owner and the parents will be registered on title as 1% owners. However, it is important to note that while this arrangement may minimize the parents’ tax implication, but the obligation to the mortgage company and all other obligations that may form a lien on the property are equally shared with the other co-owner.
The other challenge to consider when asking parents to become co-borrowers is the estate implications when the elderly parents pass away. In this situation co-borrowing parents should clearly indicate in their will to whom the property in question is to be bequeathed. The co-borrowing child upon transfer of the property because of inheritance would be responsible to pay inheritance tax. Further complication could come from other siblings who may protest the will in case where the remaining assets under the will are not divided equally, or that they decision to bequeath the property to co-borrowing sibling was done under duress. In such instances, the parents and other beneficiaries should all discuss what will happen to the property ahead of time and clearly express their wishes.
In the instance where a relative is being added to the title to assist with financing similar issues may arise. However additional challenges for the relative being added may be relatives future financing needs. For example, if the relative becomes a co-borrower the mortgage will be counted towards their debt ratio should they decide to apply for another mortgage on their own property or should they choose to purchase another property for investment purposes. In such a case, the relative would not be able to use the co-borrowing property as an asset because it is mortgaged. Furthermore, if the property where the relative is acting as a co-borrower/co-owner is rented, the co-borrower may only use 50% of rental income as additional income for mortgage qualifying purposes. 50% of rental income should have been deposited into co-borrowers account to confirm the actuality of the rent being paid.
While becoming a co-borrower does have its advantages and disadvantages, it is important to note that the arrangement is not permanent. The co-borrower could be removed from title of the property once the borrower can qualify for the mortgage on their own or once they find another co-borrower to replace the original co-borrower if they are unable to qualify on their own. Same could be said about parents who act as co-borrowers.
There are several things to consider when removing a co-borrower from title. The one thing to think about is the potential land transfer tax implications. Land transfer tax amount is calculated based on the value of consideration payable from co-borrower to the remaining owner on title, assumed mortgage amount , if there is a mortgage on the property or there may be no land transfer tax payable if the co-owner qualifies for one of the land transfer tax exemptions.
For example if a parent/relative is receiving compensation for being removed from title, this amount should be counted in the land transfer tax calculations. If the parent/relative are not being compensated and the only consideration passing between the co-borrower and the owner is the amount of the mortgage being assumed, then the land transfer tax would be calculated from that amount. If, for example, the mortgage is $500,000 and the title is held 50/50, then the amount of mortgage being assumed would be $250,000. And as such the land transfer tax would be calculated from that amount. It is important to note that when a co-borrower is being removed from title, the remaining owner/owners must either get consent from their current mortgage provider or requalify for a brand new mortgage.
There is some debate over the issue if the remaining borrowers wish to increase their mortgage amount, what amount should the land transfer tax be calculated from ; the old mortgage or the new one. The way to analyze this situation would be to look at the mortgage that is currently being held by the co-borrower, as they are “giving up” their share of their current mortgage before the remaining co-owner can take over the property and put on a new mortgage.
It is important to note that unless there is money changing hands between spouses for removing one spouse from title, title transfer between spouses are usually exempt from land transfer tax.
To diminish liability and to avoid conflicts in the future, it is important to prepare a contract that outlines the rights and responsibilities of each co-borrower. Therefore, to act as a co-borrower one must determine their own future financial and ownership plans. Once everyone is on the same page about how the co-borrowing relationship is going to work, each persons’ rights and obligations with respect to the property and carrying costs, the wills have been updated to consider the co-borrowing relationship and everything is clearly outlined in the contract, all parties can rest easier knowing that their rights are protected.
