Thanks to tighter mortgage qualification rules and higher-priced real estate—particularly in the greater Vancouver and Toronto areas—it’s not always easy to qualify for a mortgage on your own merits.
You may very well have a great job, decent income, a husky down payment and perfect credit, but that still may not be enough.
When a lender crunches the numbers, their calculations may indicate too much of your income is needed to service core homeownership expenses such as your mortgage payment, property taxes, heating and condo maintenance fees (if applicable).
In mortgage-speak, this means your debt service ratios are too high and you will need some extra help to qualify. But you do have options.
A co-signer can make all the difference
A mortgage co-signer can come in handy for many reasons, including when applicants have a soft or blemished credit history. But these days, it seems insufficient income supporting the mortgage application is the primary culprit.
We naturally tend to think of co-signers as parents. But there are also instances where children co-sign for their retired/unemployed parents. Siblings and spouses often help out too. It’s also possible for more than one person to co-sign a mortgage. A co-signer is likely to be approved when the lender is satisfied he/she will help lessen the risk associated with loan repayment.
Under the microscope
When you bring a co-signer into the picture, you are also taking their entire personal finances into consideration. It’s not just a simple matter of checking their credit.
Your mortgage lender is going to need a full application from them in order to grasp their financial picture, including information on all properties they own, any debts they are servicing and all of their own housing obligations. Your co-signer will go through the wringer much like you have.
What makes a strong co-signer?
The lender’s focus is mainly centred around a co-signer’s income coupled with a decent credit history. Some people think if they have tons of equity in their home (high net worth), they will be great co-signers. But if they are primarily relying on CPP and OAS while living mortgage free, this is not going to help you qualify for a mortgage.
The best co-signer will offer strengths you currently lack when filling out a mortgage application on your own. For instance, if your income is preventing you from qualifying, find a co-signer with strong income. Or, if your issue is insufficient credit, bring a co-signer on board who has healthy credit.
There are typically two different ways a co-signer can take shape:
- The co-signer becomes a co-borrower. This is like having a partner or spouse buy the home alongside a primary applicant. This involves adding the support of another person’s credit history and income to the application. The co-signer is placed on title for the home and the lender considers this person equally responsible for the debt if the mortgage goes into default.
- The co-signer becomes a guarantor. In this scenario, he/she is backing the loan and vouching you’ll pay it back on time. The guarantor is responsible for the loan if it goes into default. Not many lenders process applications with guarantors, as they prefer all parties share in the ownership. But some people want to avoid co-ownership for tax or estate planning purposes (more on this later).
Nine things co-signers need to keep in mind
- It is a rare privilege to find someone who is willing to co-sign for you. Make sure you are deserving of their trust and support.
- It is NOT your burden to feel you MUST co-sign for anyone. Carefully think about the character and stability of the people asking for your help, and if there is any chance you may need your own financial flexibility down the road, think twice before possibly shooting yourself in the foot.
- Ask for copies of all paperwork and be sure you fully understand the terms before signing.
- If you co-sign or act as a guarantor, you are entrusting your personal credit history to the primary borrowers. Late payments hurt both of you, so I recommend you have full access to the mortgage and tax account information to spot signs of trouble the instant they occur.
- Understand your legal, tax and even your estate’s position when considering becoming a co-signer. You are taking on a potentially large obligation that could cripple you financially if the borrower(s) cannot pay.
- A prudent co-signer may insist the primary applicants have disability insurance protecting the mortgage payments in the event of an income disruption due to poor health. Some will also insist on life insurance.
- Try to understand upfront how many years the co-borrower agreement will be in place, and whether you can change things mid-term if the borrower is able to assume the original mortgage on their own.
- There can be implications with respect to your personal income taxes. You may accumulate an obligation to pay capital gains taxes down the road. This should be discussed this with your tax accountant.
- Co-signing impacts Land Transfer Tax Rebates for first-time homebuyers. The rebate amount is reduced based on the percentage of ownership attributed to the co-signer.
Tips from a Real Estate Lawyer
We spoke with Gord Mohan, an Ontario real estate lawyer, for unique insights based on his 22 years of experience.
“The cleanest way to deal with these situations is for the third party (which is typically a parent) to guarantee the main applicant’s mortgage debt obligation,” Mohan says. “This does not require the guarantor to appear on the title to the property, and so it prevents most later complications.”
Following are five key suggestions from Mohan:
- Co-signers should seek independent legal advice to ensure they fully understand their obligations and rights.
- All parties should have updated wills to address their intentions upon death and give their executor clear direction with respect to their ownership postmortem.
- Many co-signers try to minimize future tax impact by opting for 1% ownership and having a private agreement that the borrowers will indemnify them or make them whole if there is a tax bite down the road.
- Some co-signers try to avoid future tax consequences completely by having their real estate lawyer draw up a “bare trust agreement”, which spells out that the co-signer has zero beneficial interest in the property.
A bare trust agreement can come in handy for the Land Transfer Tax (LTT) Rebate, enabling the co-signer to apply for a refund from the Ministry of Finance – LTT bulletin. – by Ross Taylor