Cosigners and Mortgage
Mortgage companies can seem pretty harsh and unforgiving if you’re a first-time homebuyer with limited funds and a poor credit score. However, the US has one of the biggest and most accessible mortgage industries, with a huge number of options for homebuyers who can’t cover the necessary funds.
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One such option is a cosigner. But how can they help you, when do you need their help, what are the limits of their power, and can they stake any claim on your home?
What is a Cosigner?
If your credit score is poor, your debt-to-income ratio is low and you can’t acquire the mortgage loan you need, a trustworthy family member with a strong credit history can co-sign a loan for you.
A cosigner is added to the mortgage documents alongside the primary borrowers when they don’t fully qualify for the loan on their own merits. Co-signing a mortgage can greatly increase the odds of it being accepted as it will look decidedly more appealing to a lender.
The cosigner name’s will be added to the mortgage loan documents, including the deed of trust. However, they will not own the property (or any share in it) and their names will not be on the property deed.
A cosigner often needs to have a family relationship with the borrower, but it can also be someone with a “family-type” relationship, such as a long-term friend.
How a Cosigner Can Help You Get Approved for a Mortgage
There are several types of home loans available. The two main options are conventional mortgages and FHA mortgages. Conventional loans require a down payment of at least 5% for first-time buyers and private mortgage insurance payments must be made for all down payments less than 20%
The lender will check the credit scores and reports of both the applicant and the co-signer during an application. These need to meet very specific criteria with regards to credit scores (at least 620) and debt to income ratios (no more than 50%).
An FHA home loan is a little more forgiving. You can apply with as little as 3.5% and unlike conventional mortgages, which are backed by private lenders, FHA loans are backed by the government. You can acquire an FHA loan with 1 or 2 co-signers, but they need to have a debt-to-income score of less than 70% if your down payment is less than 20%.
What a Cosigner Can’t Do
Even if a family member with a strong credit history agrees to co-sign on a loan, you still need to meet the credit score requirements. For a conventional mortgage that requirement is 630, for an FHA loan it’s 580 with a 3.5% down payment and 500+ with a 10% down payment.
Your down payment is a cash sum paid prior to the closing costs. Your cosigner may agree to give you a loan if they are a close family member, but they are not obligated to do so. As for your debt-to-income score, this calculates how much of your monthly income is spent on debt. If this is high, typically beyond 43%, then you may be refused even with a cosigner as it shows that you can’t meet the monthly payments.
Risks of Cosigning a Mortgage?
Co-signing a mortgage carries some serious risks for the cosigner. They will become financially responsible for the mortgage in the event that the homeowners do not meet their mortgage payments. This can impact greatly on their financial situation and their credit score and it will also appear on their credit report as a potential liability, thus reducing their chances of acquiring credit in the future.
Late payments by the borrowers can negatively impact a cosigner’s credit report and credit score. If those payments stop entirely, the lender may chase the cosigner to cover the remainder of their loan and because they don’t hold any rights to the property being contested, they may be forced to sell their own asset to cover the cost.
Protecting the Cosigner
As a borrower with a co-signed mortgage loan, the onus is on you to protect the cosigner and remove their obligations as soon as possible. It goes without saying that you should always make your payments on time and avoid making payments that are late or under the minimum amount.
In addition, you should seek to refinance the mortgage at the first opportunity. This can typically occur after you have been in the house for 2 or 3 years and have made all your payments on time. You have established a degree of trust with the mortgage provider and can now seek to refinance without the help of a cosigner.
How to Know if you Need a Cosigner for a Mortgage?
If your credit score is poor and your debt-to-income score is worse, a cosigner can’t help you and you should look into rebuilding your credit and paying off some of those loans. Try options like debt settlement, debt consolidation or a debt management repayment plan, all of which will do some damage to your credit score in the short-term but will benefit you in the long-term. You’ll become a viable borrower that lenders are happy to work with and there’s a greater chance you will meet the underwriting criteria.
If you have a low income and can’t get a mortgage as large as you want, it might be time to consider a cosigner. Not only will they improve your chances of getting a mortgage big cover to cover the house you want, but you’ll also be offered more favorable mortgage rates.
Alternatives to Co-Signing a Loan
A cosigner is a great option if you need a little assistance getting over the line and finalizing your loan application. They can help you acquire a loan to purchase your primary residence, after which you can start building some equity and working towards getting that cosigner off the mortgage documents.
It won’t necessarily benefit you to do so, but it’ll be a great weight off the cosigner’s shoulders. If it’s a responsibility too far or you don’t have anyone willing to co-sign, try the following alternatives.
If the borrower doesn’t want to ask too much of the cosigner, a land contract may be a better alternative. In this case, the cosigner simply buys the house themselves and then offers it to the borrower on a land contract. They deal with the bank and if anything happens, they keep the house and can use it as collateral.
In a traditional cosigner agreement, the cosigner has all of the responsibility and none of the assets. With a land contract, they have both, which may provide more incentive for the borrower to keep making those mortgage payments.
A larger down payment means a smaller mortgage loan. A good alternative to a cosigner, therefore, is to ask for a small loan from a family member. You can use this to reduce interest rates, get a big house/smaller mortgage, and generally improve your chances of getting what you want. All without resorting to a cosigner.
You can offer to repay the loan lender once you get back on your feet and have claimed a sizeable portion of home equity. You could even use a home equity loan or home equity line of credit to offer a one-off repayment or a structured repayment agreement.
WaitIf you can’t get a cosigner then heed the warning—now’s not the right time for you to buy a house. It can be hard to walk away after spending months shopping for homes and looking forward to owning your own home, but it’s better to bide your time and get a good deal than to force it and get mortgage rates that you’ll regret for the next few decades.