Our article today involves making the best of a bad situation. Marc and Andree have had some credit problems in the past. Buying a home will put the finishing touches on their credit reconstruction. Two years ago Andree's job was declared redundant. They went without her income for almost a year. They tried to explain to their creditors, to no avail. They struggled through that period without going bankrupt and as of today, all their former creditors have been paid in full.

They present themselves to their bank in order to qualify for a mortgage. They have $12,000 accumulated for their downpayment. Due to their past, the bank and Canada Mortgage and Housing Corp. (CMHC) demand that they involve Marc's parents. This involvement is by way of co-ownership, not just co-signing. Let me explain...

a co-signer would be bothered by the bank only after the bank had exhausted every means available to collect from the primary debtors (the kids). Co-owning means that the third party (Marc's parents) can be involved from day one in the case of arrears, and, even worse, if and when Marc and Andree's sell their house for a profit, there would be capital gains tax payable by Marc's parents on that profit.

The answer to the problem lies in the type of financing required. The purchase price of the home is $120,000. Since the kids only have $12,000 down, the amount of financing required exceeds 75% of the value of the property (a high ratio mortgage). We approached a lender to accept the kids (and their credit story) up to 75% financing (a conventional mortgage).
 
 

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This lender agreed to finance the first mortgage ($90,000) at a slightly higher rate than normal, reflecting the poor credit in the past. We then approached a private investor who happened to have the $18,000 shortfall (that's $120,000 purchase price, less the downpayment of $12,000, less the first mortgage of $90,000) in his RRSP. We offered this investor a second mortgage on the property, as well as Marc's parents as co-signers, not co-owners. The rate of interest on this mortgage is considerably higher than the first mortgage, but there was no capital gains implication on the parents, nor was there any CMHC surcharge(1) to pay. Marc and Andree found that this was the fair way to proceed. We took a three year term on both mortgages. At the term expiry (three years from now) we will amalgamate both mortgages, hopefully avoiding the CMHC surcharges. If the combined balances of the mortgages versus the value of the house (in three years) is less than 75% financing, and if the kids keep their credit on track, we will have succeeded in accomplishing what they set out to do at the onset....prove to the world that their credit problem was temporary.

The final outcome still allows our kids to buy. It does not put a strain on the parents since their responsibility is restricted to only the second mortgage, and our method of financing avoids any capital gains problem in the future.

1. up to 2.5% of the amount of the total mortgage, or $2700 in this case.