In Canada, real estate transactions are typically conducted through a legal process called "closing." During closing, the buyer pays the seller the agreed-upon purchase price for the property, and the seller transfers ownership of the property to the buyer. The agreed upon purchase price is made up of cash from the seller (down payment) and financing from a lender (mortgage). For a primary home purchase, the maximum mortgage amount in Canada is 95% of the property value which, in a typical purchase, is set by the purchase price listed in the contract.
To make their property more attractive, sellers may want to offer an incentive to buyers in the form of cash back.
"Cash Back" from a seller can be presented in several different ways such as decorating allowance, appliance allowance, landscaping allowance etc., but they all have the same end result...lowering the perceived purchase price of the property.
It is generally not permitted for a buyer to accept cash back from the seller as part of the transaction. This is because Canadian law requires that the purchase price of the property be accurately reflected in the official documentation, such as the purchase agreement and the transfer of land. If the buyer were to receive cash back from the seller, it would effectively reduce the purchase price and could potentially result in tax evasion or mortgage fraud.
Lenders require proof of the purchase price and will only provide financing based on the official purchase price. This proof is typically in the form of the purchase contract. If an incentive of cash back of any kind is listed on the purchase contract or in the property listing, the lender will deduct it from the purchase price and use that lower amount as the purchase price/value of the property. The 95% loan-to-value maximum is then applied using the lowered amount.
Example: a home is offered to you at $350,000 with $5,000 decorating allowance. You expect your down payment of 5% to be $17,500 and you're mortgaging the other $332,500. But when you go for mortgage approval, upon seeing the allowance being offered in the documentation, the lender/CMHC has reduced the purchase price to $345,000 and is now only approving you for 95% of that reduced amount, equalling $327,750.
You now have a shortfall of $4750 which you are expected to bring to the lawyers...the seller still needs their money and you agreed to a purchase price of $350,000. So you have gone from a down payment requirement of $17,500 to $22,250...so much for $5,000 cash back.
What can be done to avoid this? Well, if the seller is willing to take $350,000 but hand out $5,000 from pocket, then they need to be willing to sell for $345,000 with $0 cash back. Rewrite the offer to $345,000.
Another time that cash back comes up is during home inspection. Often when repairs are needed the seller will offer to pay cash to the buyer. This must be listed in the contract as an amendment and will also result in the lender reducing the purchase price, resulting in the same shortfall situation as above for the buyer. To avoid this, it can be arranged that the $ be paid directly to a professional who will be completing the repairs, or simply reduce the purchase price by the same amount.
To avoid these potential legal and financial issues, it is important for buyers and sellers to ensure that the purchase price is accurately reflected in the official documentation and that there are no side agreements or informal arrangements that could compromise the integrity of the transaction.
As a seller, listing with a licensed realtor can help you properly market your home with an accurate value to ensure your best success at selling. As a buyer, using a licensed real estate agent and a knowledgable mortgage broker will make sure you don't run into these (expensive) surprises late in the process.
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