When family members are involved in any form of business transaction, emotions are virtually guaranteed to fly high. Throw real estate into the mix – with its accompanying nostalgia, maintenance costs and complex purchasing processes – and you can be in for quite a show.
While one family purchasing one property is simple enough, troubles often arise when relatives are seeking to divvy up a deceased family member’s home or embarking upon a complex real estate-focused investment strategy. And given the recent escalation of housing prices across the country, combined with the slowing economy, it’s likely more Canadian families will be joining forces when it comes to matters of real estate.
Whether it’s purchasing a home from a family member to save a few dollars, investing an RRSP in a relative’s mortgage to avoid the turmoil of the stock market or purchasing a rental property together to generate a little extra income, there are plenty of opportunities for mortgage brokers/agents to help families stick together while increasing their net worth. It’s important to keep in mind, however, that these situations must be approached with a delicate hand.
Sales between relatives
Over the last 12 months, Graeme Moss, manager with Fair Mortgage Solutions in Hamilton, Ontario, has seen a drastic increase in the number of clients looking to purchase homes from a family member.
While non-arm’s-length deals were an occasional occurrence 10 years ago, Moss says he’s done 25 deals in the past year. The presence of an existing mortgage makes this type of transfer complicated – and leaves plenty of room for confusion on behalf of the client and, potentially, the broker.
“If it’s mortgage-free, it’s usually a simple transfer. It’s a little more difficult when there’s a mortgage on it,” he says. “That’s why the most important thing to do with these types of deals is to sit down with the whole family and make sure you understand the whole situation.”
Moss adds that the more family members involved, the more room for confusion – and family tiffs. He offers the example of a family where the mother had died and her five children were looking for a way to evenly split the house proceeds. While that seemed straightforward enough, complications arose when two of the brothers sought to buy the property.
“It took about two months to complete – these types of deals usually involve a slower process,” Moss says. “The property has to be appraised at a fair price, all the relatives have to agree on it and there is heavy lawyer involvement.”
In the end, the two brothers purchased the home for the appraised amount and the cash from the sale was evenly split among the three other siblings. While it turned out okay, Moss says things could sour down the road.
“In these situations, the potential for problems is much greater – especially if house prices rise,” he says.
Lenders are typically open to relative-to-relative sales, although they do require extra documentation – especially if it’s a private sale with no realtor involved, Moss says. In these situations, an appraisal is frequently required.
“Banks are worried about relatives overvaluing their property and then selling it,” Moss explains. “But I’d say 90% of the time the offer is below market value.”
Moss offers the example of another home transfer that he originated where an older couple was retiring and wanted to move to a smaller home after selling their existing home to their son. The house was sold to the son at the appraised price, but the parents wanted to give their son a down payment from the value of the home. As a result, they ended up knocking off five per cent of the price of the house and the son used the money to put towards his down payment.
If Moss could offer other mortgage brokers one tip for ensuring relative-to-relative sales go smoothly, he suggests partnering with a good lawyer. “Find a lawyer that’s skilled in real estate,” he says. “You can get seven people in a room yelling and screaming, and a lawyer can make them all quiet simply by coming up with logical and fair solutions.”
As the stock market continues its rollercoaster ride, many homeowners are jumping off and looking for new places to invest their RRSP nest eggs. One of the places they’re looking? Their family members’ mortgages.
“If you lend your RSP to someone’s mortgage, you have an investment backed by real estate, which is seen to be relatively low risk,” says Chris Karram, a financial planner with Safebridge Financial in Toronto.
Investing a self-directed RRSP in a family member’s mortgage is an alternative to private mortgage investing or less risky investments such as GICs or bonds. If an investor has $200,000 in RRSPs, for example, and a family member has $200,000 left on a mortgage, the investor can pay off the mortgage and receive payments directly from the family member.
While this is a relatively safe venture for the investor – and arguably safer than a private mortgage, since the investor knows the individual who will be repaying the amount – it also offers an advantage for the family member, because there is some flexibility in the amount of interest that is charged. That flexibility usually amounts to approximately two per cent – so if the going rate is 5.5%, an investor could charge 3.5%.
“The only problem with this strategy is that you’re putting all your eggs in one basket,” says Karram. “It’s different if you have other businesses or a more diverse investment portfolio. But if your biggest asset is your home, and your second biggest assets are your RSPs, you’re not diversified.”
There are also a large number of fees involved with this type of investment strategy. Despite the fact the funds are coming from an individual’s own investments, a mortgage broker must ensure that the RRSP mortgage is administered by an approved lender under the National Housing Act.
Because the lender is helping with the setup of the mortgage, and isn’t going to acquire interest from it, it will likely charge rather hefty upfront fees. In addition, an accurate appraisal is often required and, regardless of the loan-to-value amount, the RRSP mortgage must be insured by a Canadian default insurer – and the associated premiums must be paid.
“The only person it makes sense for has assets outside of the RSP and their home,” Karram reiterates. “We’d prefer it if they were more advanced investors. By no means is this strategy for everyone – it’s important to make sure it’s right for the people involved.”
Although many experts are expecting a correction in the more expensive housing markets in the country, prices are still out of reach for many homebuyers. For this reason, many family members – and friends and business partners – are opting to purchase properties together.
Unlike cosigning a loan, sharing a mortgage involves including all involved names on title – which means the costs, profits and upkeep are split according to percentage of ownership of each party. The only problem is, the more parties, the more opportunities for disagreements – which is why lenders such as Vancity have created products that are specific to this type of loan.
“People are so touchy about money and property,” says Ryan McKinley, mortgage development manager at Vancity. “Our product eliminates the stress.”
While it’s possible to process a shared mortgage without Vancity’s Mixer Mortgage, which was introduced in 2006,
McKinley says the company’s product streamlines what can often be a complicated process.
“The process requires a few different steps,” he says. “It’s something we’ve always been able to do but, in a package, it’s easier for the client to understand.”
The Mixer Mortgage guides homebuyers through the process by presenting them with a legal co-ownership agreement. The agreement, which isn’t necessarily included in all shared mortgage agreements, lays out the purchase price, the percentage of ownership, the parties responsible for repairs and the process that will be involved when the property is sold.
“The co-ownership agreement is the number one thing that helps avoid disputes between parties,” McKinley says. “When family members are involved, things can get heated.”
The product also makes sure homeowners address various insurance needs – such as life and disability – so
that they can protect themselves in case something happens to one of the other owners on title.
While the product is only available through Vancity mortgage specialists, mortgage brokers can offer a similar product by utilizing existing products in the marketplace – and clearly outlining the process and properly educating their clients.
“The main thing about this product is that it’s a new way of thinking about homeownership,” McKinley says. “The challenge is getting people to understand exactly what’s involved.”
Other ways to share
In countries such as the UK, where housing affordability disappeared long ago, mortgage lenders and government bodies are uncovering new ways to allow first-time buyers to access the help of others to earn a spot on the property ladder.
New Build HomeBuy
· Requires the buyer to fund between 25-75% of the cost of a property while the remainder is bought by a local housing association. Housing associations have replaced local authorities and councils as the main providers of affordable social housing in the UK.
· A subsidized rent is paid on the part of the property the buyer does not own and the homeowner is able to buy back shares from the housing association (a process known as ‘staircasing’) until they own 100%. When the property comes to be sold, both parties simply pocket their relative share of the equity based on the percentage they own. Depending on how house prices have performed, this could be enough for a first-timer to use as a deposit on their own home.
Open Market HomeBuy
· Launched in October 2006, this product is open to all first-time buyers and, as the name suggests, on any property. But they have to prove they can’t afford to buy their first home alone.
· Open Market HomeBuy works on a shared equity, rather than shared ownership, basis and requires the buyer to qualify for a conventional mortgage of 75% of the property value. The remaining 25%, known as the equity loan, is provided in equal measure by the government and a specific lender.
· The 75% conventional mortgage comes with a five-year tie-in and is charged at standard market rates of interest – usually base rate plus one per cent. The 25% equity loan is interest-free during this time to both the government and lender, and can be redeemed penalty-free. At the end of the five years, a rate of three per cent will become payable on the lender’s part of the equity loan, but there will still be no interest to pay on the government’s portion.
· Launched in January 2008, this product has opened the gates for all first-time buyers, allowing them to purchase a share of any property, anywhere in the country, as long as it costs less than £250,000. This time, the other party is a private investor, whom the first-time buyer never even has to meet.
· The company behind the product, called Joint Equity, acts as a middle-man between these investor-partners and first-time buyers known as owner-partners.
· The owner-partner can choose to purchase between 25-75% of the home while their investor-partner puts up the remainder. The two parties must then put down a 10% deposit on their relative shares. The owner-partner must pay what is effectively rent – although it is termed an ‘investor return’ – of six per cent compound growth on the investor-partner’s original stake. This is paid monthly.
Source: Mortgage Advisor Online