As the price of real estate continues to steadily rise in Ontario and as mortgage qualification rules continue to become more restrictive, an increasing population finds themselves unable to purchase a home without assistance from loved ones. In order to satisfy lenders who are ever sensitive to the risk of default, many parents choose to add themselves as a co-borrower and co-owner to diffuse the risk for the lender.
However, volunteering to add your name to title and taking the role of a borrower can be fraught with risk. Any person looking to assist a loved one by adding their name to title and becoming a co-borrower should consider the following risks.
LIABILITY UNDER MORTGAGE
Even though a primary borrower and volunteering co-borrower may both have an understanding that the former will be solely responsible for the mortgage obligations, each borrower is fully liable for all mortgage obligations in the eyes of the lender. In other words, there are no “primary” or “secondary” borrowers, but only borrowers. This remains the case even when borrower and volunteering co-borrower own the property in different proportions (for example, the primary borrower owns 99%, and the volunteering co-borrower owns the remaining 1%).
Consequently, if continual defaults result in the lender suing both borrowers for outstanding loan obligations, the co-borrower may have few options to defend itself against the lender.
Voluntary borrowers should therefore make sure they understand the extensive terms of any mortgage loan that they agree to sign.
INCOME TAX IMPLICATIONS
Generally, each owner is responsible for the income taxes in connection with their ownership of a property. For owners who occupy the property as a principal residence, the Income Tax Act generally exempts them from paying capital gains taxes related to their residence. When only a portion of the owners occupies the property as a principal residence, the issue of attribution of the capital gains becomes a significant concern.
Consider the following example: Lily does not qualify for her desired financing without adding her mother, Mary, to title as co-owner and co-borrower. Mary agrees to this arrangement on the condition that each will own a 50% interest in the property. Upon the sale of the property, the Canada Revenue Agency will likely attribute 50% of the capital gains to each owner. Because the property is Lily’s principal residence, it is unlikely she will incur any taxes from her 50% interest in the proceeds of sale; however, Mary will be responsible for her 50% interest in the capital gains for her share of the property.
One way of managing this risk is by minimizing the ownership interest of the non-occupying owner, resulting in the capital gains being likewise apportioned between the owners. However, it may not be the intention of the voluntary co-owner to minimize their ownership interest. Volunteering co-borrowers should therefore consider seeking advice about potential tax consequences before entering any agreement.
OWNERSHIP & CONTROL OF THE PROPERTY
Parents or loved ones volunteering as a co-borrower and co-owner would be well-advised to consider each party’s rights over and responsibilities for the property. As with any joint venture, parties should always consider documenting their intentions regarding responsibility for liabilities and including an escape mechanism in case plans do not come to fruition. The following are some questions to consider:
- Is the volunteering co-owner obligated to release their share in the property once the present or subsequent lender no longer requires that they be on title? If so, in exchange for what consideration?
- Is the volunteering co-owner obligated to act at the direction and for the benefit of the primary owner?
- Which owner(s) can trigger a sale or other disposition?
- What event(s) would trigger a sale or other disposition?
Depending on your answers to these questions, it may be prudent to crystalize the arrangements in the form of a co-ownership agreement, partnership agreement, or trust agreement to avoid any conflict or misunderstanding in the future.
Volunteering as a co-borrower and title holder can be a significant risk that requires planning and preparation. The previous considerations are not exhaustive, and the details of the transaction you are considering may additionally have a significant impact on your estate plan as well as on your rights under family law. Additionally, volunteering as co-owner may prevent the primary owner from getting full access to certain tax benefits, including a first-time homebuyer rebate or HST New Home/Rental Rebate.
At Hummingbird Lawyers LLP, our real estate lawyers have vast experience and success with providing legal advice and direction when it comes to getting a mortgage, co-owning a home, and changes in title.
For more information, please contact Hummingbird Lawyers LLP. Our team is always available to help.