Joint Borrowing: Checklist for Disaster Management

In a climate of rising interest rates, Home Equity Lines of Credit (HELCO) and other joint borrowing opportunities can present a new risk for two generations in the family.  Joint borrowers need to be aware of the dangers ahead and the tax consequences; all reasons why that’s an important part of a year-end tax planning conversation.

What is Joint Borrowing?  Joint borrowers are equally responsible for repaying balances owing on a loan.  Therefore, if one borrower fails to pay on time, the lender can demand that any borrower listed in the loan agreement pay the entire amount.

Is Being a Guarantor Different?  In general, a co-signer or joint borrower is listed on the title of the property, while a guarantor is not.

Will There Be Tax Consequences? If you are co-borrowing to help your children with a home mortgage, and your name is on the title, any increase in value will have capital gains consequences.  Also, there may not be a Principal Residence Exemption available on a subsequent sale of the property.  Be sure you can show you are not the beneficial owner of the property.  Documentation that shows the children made the down payment and all subsequent payments is important should CRA question this.  Parents can also request documentation from the lender to remove their name from the loan once the required credit history or other requirements have been met by the children. 

Tax issues can happen in reverse, too.  If a child co-signs for a parent’s mortgage, they could lose future first time homebuyer tax credits.  All of these scenarios require consultation with tax specialists.     

What happens in the case of default?  Aside from the obvious – the co-borrower must pay – there is some tax relief.  As a guarantor or co-borrower, you could realize a capital loss if the loan was for an investment property.  An allowable business investment loss could result if the loan was to finance a small business corporate that failed.

If the guarantee was to finance the operations of a small business operation, for the purposes of earning an ongoing income stream, the consequences could be different.  A guarantee of indebtedness for a corporation creates an accounts receivable, which requires an income inclusion.  If the accounts receivable are not collectible, a bad debt would result, together with a deduction.

Note that when a debt arises as a result of owning a personal use property by a person not dealing with a taxpayer at arm’s length, any loss resulting on the disposition of debt is denied. 

This is a very important consideration given that the average house price has declined 7% since its peak at February 2022, and declines may be as much as 12 to 23% more by the end of 2022, based on scenarios modelled by the Parliamentary Budget Officer.  

Co-borrowing could limit your borrowing power. What is your existing debt-to-income ratio? Will lenders shy away from you as a borrower? Your credit scores will also be affected by any late or missed payments. If the borrower stops paying altogether and the loan goes into collection, your credit score will be affected.

Lenders could sue you.  Not only would you incur legal fees to defend this, but you could suffer harsher consequences, immediately – a garnishment of your wages or a lien on your property. You could also be taking calls from loan collectors; unpleasant at best.

Joint Borrowing will affect estate planning.   The debt incurred by joint borrowing will form part of your estate, and so this needs to be considered in estate planning.  For example, will the estate be as equal as you want it to be if you have jointly borrowed with one child but not the other?  Also, will the size of the estate going to the indebted children be diminished because of this arrangement?  Legal help is required to get this straightened out.  It would also be important to make sure the co-borrowers have life insurance and possibly, disability insurance.  This is generally cheaper for the younger borrowers.

Checklist for Disaster Management.  Here is a checklist of things to do before you co-sign, joint borrow or guarantee a loan; great discussion questions between advisors and clients, too.

1. Have you discussed family relationships in case of default?  That should be your starting point.  How will that be handled?  Can you agree to be on speaking terms if things go badly?
2. How will this affect your own security or credit scores?
3. Will other children in the family expect the same – that you help them borrow?
4. Can you afford it in either case? 
5. What is the period of the loan?  Can you afford to make the payments for the balance of the period of the loan?  How will that affect your lifestyle?
6. What is the interest rate?  At the start of the loan and at variable interest rates?
7. Will more credit be extended as the principal payments on the loan are made?  You want to be sure to understand this and your obligations towards new lending.
8. What will happen if the person you jointly borrow with defaults?  How will they pay you back? There must be a plan and the terms must be agreed upon.
9. Have you read the full agreement? Do you understand it? What restrictions are there on the use of the property?  
10. What are the costs of entering into the agreement and upon default?
11. Will there be any legal costs up front? 
12. Will there by any land transfer costs?
13. Will there be any Valuation costs?
14. Will you receive a copy of all agreements and monthly account statements?  Be sure you insist on this.  Keep all of this documentation for tax purposes.
15. Is there an opportunity to discharge the loan with a full payment?
16. Are there discharge fees?  Who will pay them?  Will you receive a copy of the discharge letter?
17. Does the other borrower have life and disability insurance? Be sure you are named as a beneficiary.

Evelyn Jacks is Founder and President of Knowledge Bureau, holds the RWM™, MFA ™, MFA-P™ and DFA-Tax Services Specialist designations and is the best-selling author of 55 books on tax filing, planning and family wealth management.  Follow her on twitter @evelynjacks.

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