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Financial and tax implications of co-signing a mortgage in Canada

by Corben Grant on 20 Jun 2022

With how our real estate market stands now, getting a mortgage is not always easy. And, with rising interest rates, it may get more challenging. Luckily, there are several ways that a home buyer can try to make getting approved for a mortgage a little easier. One of the easiest is to have a mortgage co-signer.

It can take time to save money for a down payment, raise your credit score, or pay off other debts. With a co-signer, you can easily overcome a bank's qualifying criteria and be approved for a mortgage.

But getting a co-signer (or being a co-signer) is not a decision you should take lightly. You and your co-signer need to be aware of important financial and tax implications before deciding to co-sign a mortgage.

This article is for you if you are considering co-signing to get a mortgage. To avoid any issues or surprises down the road, you must understand what it entails when you use a mortgage co-signer. This article will explain how co-signing works, when it may be a good option, and the tax and financial implications for both parties.

What is co-signing?

When applying for a mortgage loan, your bank must verify your financial status to know that you can afford to pay back what you borrow. The bank will look at several factors to qualify you. These may include your debt service ratios, credit score, income, and available interest rates.

Mortgages are a lot of money for a bank to lend, so they need to ensure only the most credit-worthy borrowers are approved. As a result, it is not enough to simply pass one or two of the bank's criteria, but all of them.

If you find yourself cutting it close or falling below what the bank needs for you to get a mortgage, it can be frustrating and can throw a wrench in your home-buying plans. In this case, some borrowers may look for a different lender or simply wait to improve their financials, but these aren’t the only options.

Co-signing essentially means adding a second (or in some cases, third) person to your mortgage contract whose own financial status will also play a role in qualifying your mortgage. In addition, the co-signer assumes some level of responsibility toward the mortgage payment. Usually, this means splitting or taking over loan payments in the event of a default.

The two types of co-signing

Co-signers come in two major types. The first is a co-borrower, with whom you fully share the title to the home and the associated financial burden. Both parties are equally responsible for paying the mortgage. The other type is a guarantor, a mortgage co-signer who does not gain any title to the home but vouches to the lender for the primary borrower's credit and is responsible for taking over the debt if the first lender defaults.

Generally, banks prefer a co-borrower over a guarantor, and it may be more difficult to secure a mortgage with only a guarantor.

Co-signing vs joint mortgage

Co-signing is similar but not the same as a joint mortgage. The primary difference is that a joint mortgage tends to be a more involved relationship, whereas a co-sign may be more of an arms-length relationship. 

In a joint mortgage, both parties usually contribute to the down payment and plan to live in the home together, such as the case with a married couple. In a co-sign, on the other hand, one borrower tends to be the one to use the home and handle things like maintenance, while the other borrower is primarily used to guarantee the loan and provide their financial backing. If you aren't sure which is right for you, consider talking to a mortgage broker who can help you understand what each would mean for your purchase.

Who can be a co-signer?

There are no real restrictions on who can be a co-signer. The most common arrangement is for parents to co-sign a mortgage with their children to help them buy a home. It may also be done the other way, with children helping by consigning a retired parent’s mortgage. Your co-signer may also be a sibling, spouse, friend, business partner, or anyone who is financially stable and with whom you have mutual trust.

Choosing the right co-signer

Just because anyone could be a co-signer in theory, this doesn't mean that just anyone will be a good choice. Your co-signer needs excellent financial health because they will be subject to the same qualifications as the primary borrower, such as a good credit score, reliable income, and low debt service ratios. 

An ideal co-signer will make up for weaknesses in your financial profile. For example, if your credit score is low, a good co-signer would be someone with a high credit score. If your income is insufficient, banks will like a co-signer with a high income. Picking a suitable co-signer will make sure your mortgage has the best chance of being approved.

You also need to be a reliable person yourself, as asking someone to co-sign is a big favour and an enormous burden to put on someone. No one owes you a co-sign on a mortgage, and they may be required to turn you down no matter how good your relationship may be. Ultimately, it is a matter of whether or not it makes financial sense, and you should not let emotions cloud your judgment in this regard.

Benefits of co-signing a mortgage

The most obvious benefit of consigning is to make your mortgage more affordable or make you more likely to be approved for a larger mortgage. It can also be an excellent way to solidify a relationship between two parties. For example, Business partners may decide to co-sign on an investment property to achieve joint ownership over the asset.

The benefits are more obvious for the primary borrower who can get a mortgage, but there may also be benefits for the co-signer. For example, they may be able to share in the property's equity and could look at it as an investment.

Risks of co-signing a mortgage

Though consigning is a good option for some, it is not without risk and should be carefully considered.
 

Obligation to cover mortgage payments

The most evident risk is that, as a co-signer, you take responsibility for the loan repayment along with the primary lender. This can affect you in two major ways. For one, it can affect you financially if your co-signer misses a payment and you are surprised with the obligation to pay it. It can also have an adverse effect on your credit score as missed payments will appear on both co-signers' credit reports. This means that you are allowing your credit score to be affected by someone else's decisions, which could damage your score.
 

Increased debt service ratios

Another issue can arise based on your debt ratios. When you get a mortgage, your lender will need to verify how much debt you have. A co-signer can help by increasing the overall debt capacity, but this goes both ways. When you co-sign a mortgage, this debt is also included in your debt ratios, even if the primary borrower covers all of the mortgage payments.

This can cause problems if you try to get another mortgage or other loans. When the bank checks your debts, they will include this mortgage in your total debt obligations, limiting your ability to borrow more in the future.

Long term commitment

You should also consider the length of your commitment in a co-signed agreement. Mortgages can take decades to pay off, so this obligation will not go away anytime soon. You should be confident in your long-term financial health before considering consigning a mortgage.

Tax implications

Finally, there are other tax implications involved in co-signing. For example, if you help someone buy a home by consigning their mortgage, you have a stake in the ownership; it is also counted as your property. If they decide to sell down the line and the home has increased in value, you may be required to pay capital gains tax.


Issues for a primary borrower

There is much less risk to a co-signing agreement for a primary borrower, but there can still be some things to consider.

For example, if you are buying a first home and plan to use a land transfer tax rebate, having a co-signer can limit your ability to take advantage of this option. This will depend on how much ownership a co-signer has. 

One option to avoid this is to opt for a guarantor co-signer over a co-borrower, though this is often harder to be approved for. Another option would be for the co-signer to use a Bare Trust Agreement to forfeit any beneficial interest in the property, allowing you to get a full rebate.

You should also consider that a co-signer is only involved with your mortgage agreement. Other costs like closing costs, property taxes, or home insurance will not necessarily be their responsibility, so you need to be prepared to cover these costs as well.

Should I co-sign a mortgage?

If you are looking to get a mortgage, the option of asking a co-signer has many clear benefits. But, your primary challenge is finding someone suited to the task.

Unfortunately, the relationship between a primary borrower and their co-signer is not equal, and the co-signer has a lot more to consider before they agree to sign.

The most important thing you need to know when considering whether you should co-sign a mortgage is that you have no obligation to co-sign. Even if the other borrower is a close family member or friend, it should ultimately be a decision on financial grounds alone. It can be hard to turn down someone you are close with, but it may be necessary to protect yourself from serious financial consequences. There may be other ways to financially assist a friend or family member without dragging yourself down.

You should always ensure that the primary borrower is financially stable as possible. Naturally, they won't have a perfect financial profile, or they wouldn't need a co-sign, but you should have confidence in their ability to pay as they say they can. If you have doubts, you should be very careful about accepting a co-sign.

You also need to be completely clear about your rights and responsibilities in a co-sign deal. Beyond doing your research (through articles such as this), you should seek independent legal advice before entering an agreement. Consider speaking to a financial advisor or mortgage professional.

In addition, be sure to request copies of all relevant documents and contracts for your records and review. Do not sign anything without carefully reading and understanding the terms, and go over paperwork with your lawyer if anything isn't clear.

If you do decide to co-sign, be sure to remain proactive. Keep up with your co-signer, and be diligent to avoid any missed mortgage payments.

Also, consider other things you can do to make your co-sign agreement more favourable. For example, people on a co-sign mortgage may take out life and disability insurance protection policies to cover the debt if something happens to either party. They may also opt for additional agreements between them to help minimize risk and tax implications.

For example, some co-signers will agree to take only a 1% share of the property or less to minimize the future tax impact. You may also opt for an agreement with the primary borrower to reimburse you or provide you full ownership in the event of future tax consequences.
You may also use a Bare Trust Agreement to formally recognize that you have no beneficial interest in the property's ownership. It can protect you from many tax obligations.

Conclusion

Co-signing for a mortgage is an option that can help buyers to qualify for a mortgage or achieve a higher valued mortgage and is commonly used in cases like parents assisting their children in buying a home. Despite being a standard option, you should not approach this kind of mortgage without a share of caution. Always be sure to do your due diligence and consult with a real estate lawyer before agreeing to co-sign a mortgage to avoid any potential issues that could come up.
 

 

 



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