Beware when clients co-sign mortgages

The expert Laura Parsons Mortgage Expert, Bank of Montreal

Client profile Jennifer is a widowed parent in her early 50s living in Saskatoon. She works as a high school teacher, her house is paid off, and she has $900,000 in registered and open investments as well as a defined-benefit pension.

Her son Tyler graduated from the University of Regina with a computer science degree and immediately landed a six-figure tech job. He bought his first home, a $420,000 detached in Saskatoon, six months later. Jennifer helped Tyler with a 20% down payment so he wouldn’t have to get mortgage insurance. When Tyler couldn’t qualify for a mortgage due to his outstanding student and car loans, she co-signed.

Advisor Degree of Difficulty

5 out of 10. Jennifer didn’t understand the full impact of co-signing and has little time to resolve the problem. The advisor must scramble to find a solution.

The problem

Tyler lost his job in a wave of layoffs. When Jennifer expressed concern about his financial situation, Tyler assured her he was handling things. But then, Jennifer received a demand letter for the arrears on the mortgage.

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Jennifer didn’t investigate the legal implications before she co-signed. Laura Parsons, area manager for mortgage specialists at Bank of Montreal, says this happens often.

“Co-signers are responsible for the full balance owing plus any arrears and the full amount becomes part of their credit profile. They think they’re just helping the primary holder qualify, but in reality, as co-signer they’re responsible for everything, including any condo fees, insurance and taxes. If a mortgage goes into arrears, it could have a negative impact on the co-signer’s credit rating.”

Tyler had a $335,000 mortgage with a five-year variable accelerated repayment plan of $1,165 biweekly. He has a variable mortgage at 3.2% with a 15-year amortization. His annual property taxes are about $3,500.

The dangers of co-signing

Parents often co-sign mortgages without realizing the legal implications. Here are some things you need to tell them:

• A co-signer assumes the same legal responsibility as the primary mortgage holder for the mortgage, legal fees, taxes and insurance
• The debt becomes part of the co-signer’s credit report and must be disclosed on subsequent credit applications
• A co-signer should seek independent legal advice. Draft a separate agreement with steps to take in the event of a divorce or other significant change
• All parties must agree beforehand if they will sell the house to cover any arrears; however, the co-signer has the legal right to go to court to force a sale
• Parents sometimes give a down payment for a house as a wedding gift to their children. That down payment then becomes part of the child’s family assets and value of the house. If the child’s marriage fails, the parents have no legal right to receive the down payment back
• As co-signer, you have a legal right to know whether the mortgage is up-to-date, and can request copies of the statements and other correspondence. This way you won’t be blindsided with a demand letter if the loan falls into arrears

He was four months behind when the bank notified Jennifer, and owes $9,000 and counting. Tyler received several notices, but was too embarrassed to tell his mother, not realizing she would be held financially responsible.

Read: Help clients through the mortgage process

He’s been making partial payments on all his debts, reasoning that something is better than nothing, but hadn’t asked the bank for mercy.

Had Tyler gotten mortgage insurance, his insurers could have helped him with the arrears. However, an insurer can go after the mortgage holder and any co-signers for shortfalls at any time, regardless of whether the house has been sold.

“Insurers have a default program,” says Parsons. “We know a single mom who went on arrears and the insurers helped her renovate the basement so she could rent it.”

Read: 5 must-have convos with homebuyers

The solution

Jennifer didn’t realize she had a right to ongoing details about the mortgage’s status. She should immediately contact the bank to have all mortgage correspondence directed to her, and to discuss a repayment strategy.

“There is a misconception that banks will foreclose if you tell them you’re in trouble. But there’s not much we haven’t heard before,” says Parsons. “The key is [for clients] to contact us at the first sign of difficulty so we can work with you.”

Jennifer never told her advisor about the co-sign because she didn’t think it would impact her finances. Now, she’s forced to because she has to find $10,000 to make up the arrears plus some of the property taxes.

Read: Faceoff: Mind your mortgage

Her advisor reviewed the portfolio and suggested Jennifer use the $6,000 in her TFSA, which she had put away for a vacation to Europe, to pay the arrears. After meeting with her bank and advisor, she decided to take out a line of credit against her own house to pay the remaining $4,000.

Jennifer’s advisor also met with Tyler to review his finances and developed a strict budget based on Tyler’s current income from unemployment insurance and his severance package. He also got Tyler to approach the bank and change the terms of his mortgage. By changing his amortization to 25 years, his loan type to five-year fixed and his payments to monthly, Tyler was able to save close to $700 per month. He also found a roommate to help with expenses.

Jennifer drafted a legal agreement with Tyler for loan repayment of the arrears. He is making monthly payments to her and has taken a job as a day labourer to make ends meet. When he finds a better job, he has agreed to meet with the financial advisor again to rework the budget.

Read: Rookie mistakes of homebuyers

Lisa MacColl is an Ontario-based financial writer.