It’s not unusual to find you owe some money to the Canada Revenue Agency (CRA) after filing your personal tax returns. Especially if you have neglected doing them for a few years. And like any other unexpected expense, you need to tighten your belt buckle, work even harder and try to find ways to eliminate the debt before you run up lots of interest charges and late payment penalties.
You may find other immediate obligations are more pressing, so if you’re not able to settle the tax debt right away, it is best to stay in touch with CRA and let them know your plan to reduce and eliminate the debt. They do have some flexibility. (This is a good way to manage all debt, not just tax debt.)
Occasionally we encounter homeowners whose tax debt is so large it cannot be readily paid through the normal course of life. The end result is a debt that can’t be negotiated away, with a creditor you can’t afford to ignore.
In recent months, we have dealt with several homeowners who found themselves in this predicament. In these instances, the smallest CRA debt was $40,700 and the largest more than $200,000. In each case, the debtor also owed money elsewhere – and had significant credit card balances and other unsecured debt. The size of the problem was way beyond the norm.
This seems to happen more often to small business owners and self-employed individuals. Regular folks are not immune though; we recently met a family with an unexpected $32,000 tax debt incurred as a result of selling an investment property and triggering a taxable capital gain.
You might think all these folks could just tap into their personal line of credit or take out a loan to pay this off, but these solutions were not available to them.
Fortunately, if you own a home and have decent equity, sometimes a creative mortgage financing solution can help clean things up, even if the amounts due are substantial, bank accounts have been garnished or even liens have been placed on your property.
Ways home equity can be used to pay very large CRA arrears
Keep in mind, when there is a large CRA debt, very few traditional lenders want to complete a mortgage refinance before the debt is remedied. In such a predicament, there are several ways home equity can be used to pay off CRA debt:
- If you already have a Home Equity Line of Credit (HELOC), and there is sufficient room to pay the tax debt, this can make tons of sense. You basically just write a cheque and be done with it. The interest rate is probably around prime + 0.5%, and that might be as good as it gets in these situations. This will solve the immediate problem; then you need a plan to reduce your HELOC balance by saving aggressively and paying it down. Or, ultimately you may decide it makes sense to refinance and roll the HELOC balance into your mortgage.
- Borrow money from a family member or close friend, pay the debt, then consider refinancing your mortgage and repay your benefactor.
- Borrow money from a private second mortgage lender, pay the debt, then refinance down the road. The length of time you wait to refinance depends on the strength of the file, which lender currently holds your first mortgage and when that mortgage is set to mature. A few “B lenders” have second-position financing options, which may suit this approach.
- Refinance the first mortgage to a “B lender” (alternative lender). The new mortgage amount is ideally large enough to clear CRA completely, and cover all fees and other debts.
- When there’s insufficient equity to pay CRA in full, it may be time for a negotiated settlement. My own experiences along these lines involve trustees who will file a consumer proposal on behalf of the debtor. Others report they’ve had success with skilled tax accountants.
The right solution will depend on the circumstances of each situation. It’s also important to note there are circumstances where homeowners will not be good candidates for eventual traditional lending no matter how we solve the immediate problem. This often happens when:
- Their income doesn’t meet the stress test qualification rules and they may need to work with alternative lenders allowing higher debt service ratios
- They’re self-employed with income that’s difficult to verify by traditional methods
- Their personal credit history has shut the door to traditional lenders (e.g., multiple insolvencies or recent late mortgage payments)
So, let’s examine the scenarios where each of these approaches is most appropriate.
Scenario 1. Homeowner’s finances and credit are in good shape. The only issue is a large CRA debt where no traditional lender wants to complete a mortgage refinance before the debt is remedied.
This lack of interest by traditional lenders is common when there’s a large CRA debt. CRA is a very powerful creditor which, in some instances, can take preference over all other creditors. This means we need to fix the CRA problem first, and then find the right loan to get the costs as low as possible.
The cheapest solution is to consider asking a family member or close friend if they’ll lend you the money for a short period of time (option 2 above). Funds may only be required for a month or two. If you go this route, your real estate lawyer should be involved to protect your benefactor’s interests. As soon as you can prove to an institutional lender that there’s no tax debt owing, it’s then possible to refinance the traditional way, and pay back your emergency loan hero.
Scenario 2. If you don’t have someone who can bail you out via a loan, then you would move to the second option, which is working with an experienced mortgage broker who can find a suitable lender willing to grant you a second mortgage. Ideally, that mortgage will be open without prepayment penalty. That’s hard to find with a private mortgage, so if the terms would not allow the loan to be open immediately, then having it open after a few months is also a good option.
As with the first option, once you have proof of payment for CRA arrears, you should be in fine shape to refinance your primary mortgage with your current lender. That may save prepayment penalties too, depending on your lender.
Scenario 3. Not only is there CRA debt, but the credit history is weak, resulting in a low score. It will take time to bring the file back to traditional lender status. In this case, your best option is to refinance the mortgage with an alternative lender, or first secure a second mortgage for a year or two. Our goal in this scenario is to determine what kind of lender will take on your deal once the situation is fixed; and we will recommend the lowest cost and least painful overall approach.
Scenario 4. CRA tax arrears and other unsecured debt exceeds the amount of equity that can be extracted. Keep in mind, though, if the CRA has already placed a lien on your home, you are unlikely to be able to negotiate a discounted settlement with them.
In this scenario, the homeowners might work with a trustee to negotiate the terms of a consumer proposal. At that point, all unsecured debts, including the CRA debt, are packaged together, and most proposals agree to repay a certain amount of money (usually $x per month) to all creditors over the next five years. With no further interest costs and late payment penalties.
Once the proposal has been accepted by the creditors, it might be possible that a mortgage broker experienced in this sort of lending can arrange a second mortgage to complete a lump-sum payout of the consumer proposal, or even refinance directly to an alternative lender to pay the reduced debt amount.
As you can see, when you own your own home there are many options to address the issue of large CRA tax arrears impacting your borrowing power. Obviously, some real estate markets lend themselves to this approach better than others – the more equity you have in your home, the more likely one of these solutions might work.
The key is to deal with the issue ASAP. This situation will not work itself out and CRA will not give up. Oftentimes indecision and paralysis make the situation worse than it ever needed to be.
During the process, it is best to stay in contact with your CRA case officer, and explain you are looking at different ways to raise capital to settle your debt. The process can be painful, but having the right experts on your side will make all the difference. By Ross Taylor, licensed insolvency counsellor
For advice and service contact Steven Porter, mortgage agent with Mortgage Architects at 905-875-2582, steven@1800Mortgages.ca. www.1800Mortgages.ca