Managing finances—especially when a business is involved—can sometimes feel overwhelming and complicated. Add in a pinch of rising interest rates, a dash of a loan or two and suddenly navigating the benefits and risks of it all can seem like a recipe for disaster. Fortunately, we’re here to provide you with the ingredients for success when it comes to joint borrowing.
Simply put, joint borrowers (or co-borrowers) are equally responsible for repaying balances owing on a loan. If one borrower fails to pay, the lender can demand that any borrower listed in the loan agreement pay the entire amount. In general, a co-signer or joint borrower is listed on the title of the property, while a guarantor isn’t. And while Home Equity Lines of Credit (HELOC) and other joint borrowing opportunities can lessen the load, they can also present a new risk for multiple generations in a family, so it’s important to be aware of the possible implications.
Lie: Joint borrowing never affects your taxes.
The truth is, there can be tax consequences when it comes to joint borrowing in both your personal and professional life.
If you’re joint borrowing to help a child with a home mortgage and your name is on the title, there could be capital gains consequences. The principal residence exemption available on a subsequent sale of the property could also be at risk. Furthermore, if a personal-use property, like a home, is owned by a relative and then sold at a loss, there wouldn’t be any tax relief on the loss. If roles are reversed and your child co-signs for your mortgage, they could lose future first-time-homebuyer tax credits. These are very important considerations given that the average house price has declined at least seven per cent (and potentially even more depending on where you live) since its peak in February 2022.
You can limit your risk by proving you’re not the beneficial owner of the property and that your child made the down payment and all subsequent payments. However, it’s always best to consult with a tax specialist.
There may be some tax relief for joint borrowers or guarantors, depending on how the money was used. For example, you could realize a capital loss if the loan was for an investment property. An allowable business investment loss could happen if the loan was taken to finance a small business corporation that failed.
However, if the guarantee was to finance the operations of a small business 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 aren’t collectible, a bad debt and tax deduction would result.
Truth: Joint borrowing can affect you in the future.
Before and after a loan is put into place, it’s important to confirm 1) what your existing debt-to-income ratio is, and 2) whether the joint borrowers have life insurance and, if possible, disability insurance. The debt incurred by joint borrowing will form part of your estate, 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 another? 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 on the up and up.
Find out how your credit scores will be affected by any late or missed payments, or, worse, if the joint borrower stops paying altogether and the loan goes into collection. You should also keep in mind that lenders could also sue you if you fail to make collection payments. Being sued may mean you not only incur legal fees but also suffer harsher, and more immediate, consequences. For example, you could be subject to a garnishment of your wages or a lien on your property. You could also be taking calls from loan collectors, which are unpleasant at best.
Truth: You can limit your risk.
As joint borrowers can request documentation from the lender to remove their name from the loan once the credit history or other requirements have been met, you should ask for this documentation up front. Furthermore, and most importantly, have a frank conversation about what would happen if things were to go wrong before you agree to co-sign, jointly borrow or guarantee a loan.
You can use the following as a checklist to get the conversation started with the involved parties and/or financial advisors. Don’t ever be afraid to pull in a second opinion from an experienced or secondary financial advisor, or to say ‘no’ if you’re not comfortable with the conditions—this is a big commitment with potentially big impacts!
- Have you read the full agreement? Do you understand it? What restrictions are there on the use of the property?
- Who will share a copy of all agreements and monthly account statements? Be sure you insist on this and keep all documentation for tax purposes.
- What are the costs of entering into the agreement and upon default? Will there be any legal costs up front? Will there be any land transfer or valuation costs?
- Will there be discharge costs? Who will pay them? Will all parties receive a copy of the discharge letter?
- What will happen if one party defaults? How will they pay the other back? Do you have security?
- Have you discussed family dynamics in case of default? How will relationships be managed? Can you agree to be on speaking terms if things go awry?
- How will this borrowing arrangement affect each party’s security or credit scores?
- Will other people expect that you help them with a loan? How will you afford it?
- What will be the loan period? Can you afford to make payments for your balance during this period? How will these payments affect your lifestyle or retirement?
- Will more credit be extended as the principal payments on the loan are made? Be sure you limit your obligations towards new lending.
- Will there be an opportunity to discharge the loan with a full payment or annual payments throughout the term?
- What’s the interest rate now and in foreseeable future? What are the numbers for fixed or variable interest rates? Are the interest rate terms well understood?
- Who has life and/or disability insurance? Be sure you are named as a beneficiary.