If you’re running into trouble qualifying for a loan to buy the home you want, adding a cosigner may be a solution.
In this article, I’ll talk about lending rules for loans with cosigners, the benefits and risks for buyers and their cosigners and ways to manage the risks.
What cosigning does (and doesn’t) do
When you apply for a loan, lenders assess your income, assets and credit. To qualify, you must meet the applicable guidelines in all three categories.
If your credit could use a little improvement, adding a cosigner won’t make any difference. Credit decisions are based on the worst-case credit between all applicants on a loan.
If you are a little short on assets, you could add a cosigner, but accepting a gift would probably be simpler and require far less paperwork and hassle.
If you need a leg up documenting income, that’s where adding a cosigner shines.
Occupying and non-occupying
If your cosigner will be living in your home with you, they are not actually a cosigner at all. They are simply a co-borrower.. A cosigner, for purposes of this article (what lenders call a “non-occupying coborrower”) is someone who will not be living with you.
If you are buying a vacation home or a rental property, there is no such thing as a cosigner — you are simply co-buyers.
DTI: Occupant vs.. Blended
When assessing your income, your lender will calculate a ratio of your monthly debt to your monthly income, called (less than creatively) a “debt-to-income ratio” or DTI. If your DTI is too high to meet the rules for the loan you want, you may be able to secure loan approval by adding a cosigner.
The DTI for all borrowers who will be living in the home (exclusive of non-occupying cosigners) is called the “occupant DTI”.
A “blended DTI” is calculated using all of your income and debts and all of your cosigner’s income and debts, with no regard for what your DTI would be without your cosigner. A cosigner will have the biggest impact if the loan you want allows a “blended” DTI.
Which loans permit cosigners
FHA loans and conventional conforming loans (with few exceptions), permit a cosigner, using a blended DTI. VA and USDA do not allow a cosigner.
Guidelines for jumbo loans (those over $484,350, as of this writing) vary widely. Some don’t permit a cosigner at all. Others permit a cosigner but don’t allow a blended DTI (which, if you think about it, makes having a cosigner pretty meaningless). Of those that permit a cosigner, some use a truly blended DTI, others take a hybrid approach — permitting higher-than-normal occupant DTI, so long as your blended DTI meets the standard guidelines.
The hybrid approach can give you a leg up if your DTI is just a little too high. But if you are leaning heavily on your cosigner to make your DTI pencil out (maybe you are student and have no income or you are newly self-employed and can’t yet document your income), your occupying ratio may be too high.
Limitations to loans
Some of the loans that permit cosigners have special rules or restricted guidelines when you have a cosigner in the mix. They may require a higher minimum credit score, a certain amount of down payment from you (versus a gift) or a larger-than-typical down payment. For example conventional loan options start at 3% down, but typically shift to options requiring 5% if you are using a cosigner to qualify.
Cosigners and plexes
If you want to buy duplex, triplex or four-plex with a cosigner, FHA offers loan options starting at 3.5% down. Add a cosigner to your loan, however, and FHA loan options start at 25% down. Conforming loans for duplexes start at 15% down with or without a cosigner.
Who can cosign?
Loan rules include restrictions on who is allowed to cosign for you. FHA guidelines only allow cosigners to whom you are related by blood, marriage or adoption. Many jumbo loans that allow cosigners have the same rule.
Conforming loans allow a close friend to cosign, but you may be required to document the nature of your relationship. Anybody willing to cosign is probably someone with whom you are pretty tight, but proving it can be a challenge. You may wind up digging up old vacation photos or the yearbooks, holiday cards and other memorabilia that you saved (for some reason) — they work well as evidence that you go way back with your intended cosigner.
Your cosigner generally can’t be someone with an interest in your transaction — your seller, your lender, your Realtor or your builder. This is true even if they would otherwise be permitted to cosign — if your sister, the Realtor, has offered to cosign, she probably can’t cosign too.
Cosigning Math
The ideal cosigner is someone who has a relatively low debt-to-income ratio. After all, you only need a cosigner if your DTI is too high to qualify. Mathematically, we’ll be relying on their lower DTI to offset your higher DTI.
Your cosigner’s housing expense is a big factor in how well cosigning math will work out. A retired cosigner with a paid for house and a modest pension, may be a stronger cosigner than someone with a high income who also happens to have a house payment, a couple of car payments and loan on a vacation home.
Cosigning process
Cosigning on a loan for someone else looks and feels exactly like applying for a loan on your own. A cosigner needs to provide all applicable income and asset paperwork and authorize a credit check.
The amount of paperwork required form a cosigner varies considerably with the complexity of the cosigner’s finances. If your brother works at Nike owns his home, he won’t need to provide much. If your aunt runs a business or two, has a few rental houses, a pension and income from investments… all of that stuff needs to be documented.
If you or your cosigner have any questions about the work and information that will be required, get your cosigner on the phone with your lender. A quick phone call is all it takes to get a handle on how much paperwork your cosigner will need to provide. Click here for an overview of what might be needed.
And if more than one family member is willing to cosign, consider taking the past of least resistance. If the brother and aunt above are both down with cosigning, your brother is probably the better bet.
Writing your offer
Make sure your Realtor knows you have a cosigner when they write your offer so they can include your cosigner on the paperwork. And note that the pre-approval letter will probably reference your cosigner, as well. When you negotiate with the seller, your cosigner will need to sign off on any changes to your contract.
If you forget to mention your cosigner, or a cosigner is added to your loan after you write your offer all hope is not lost. Your real estate broker can write an addendum adding your cosigner to the contract.
At closing
When you close on your home purchase, you and your cosigner will need to decide how to put your names on title – also called vesting. Cosigners will always sign the “promissory note”, agreeing to be on the hook for the loan, but you and your cosigner can decide whether they will go on title, taking an ownership interest in the property with you.
If you decide to take title together, you can choose from a variety of ways to “vest” title. You can even designate specific ownership percentages — 50%/50%, 99% to 1% or anywhere in between. If you have questions about the options for taking title, talk to an attorney (I’d be happy to provide a referral).
Who’s on the hook?
The papers you sign at closing put you and your cosigner on the hook for the mortgage equally. In fact, you are both on the hook for 100% of the mortgage — all for one and one for all.
If you don’t pay the payment, as agreed, your cosigner is legally responsible for the entire payment. This makes sense, if you think about it — a bank can’t foreclose on half a house, after all. In lending lingo, we say you are “jointly and severally” liable for the loan.
Credit reporting
Your mortgage will show up on your cosigner’s credit report. With a code indicating they account is joint or that they are a “maker” and not the primary borrower.
If you pay your monthly payments as agreed, your mortgage payment will reflect favorably on your cosigners credit report. Mortgages are given a lot of weight in credit scores, so your timely payment history may even boost your cosigner’s scores.
On the other hand, if you pay a payment 30 days late or more, your missed payment will damage your cosigner’s credit score. Even one late mortgage payment will have a serious negative impact on your cosigners credit report and lower their credit scores — likely significantly. And your late payment will remain on their credit report for 7 years. So be sure and pay your payments on time!
Contingent liability
When your cosigner next applies for a mortgage, car loan, credit card or any other financing their new lender will see your mortgage. Even if you’ve been paying your payments on time (because of course you have), there is still another issue — the payment itself.
Your mortgage payment, becomes part of your cosigner’s debt-to-income ratio. If their DTI is too high, they may be turned down for their loan or qualify for less than they want to borrow.
There is an easy solution to this problem. If you provide proof that you pay the payment, most lenders will disregard it when calculating your cosigner’s DTI under “contingent liability” rules. The cosigner is only responsible to pay the payment under the contingency that you don’t.
You’ll be asked to provide proof that you paid the past 12 months of payments on time and from an account that is not connected to your cosigner.
Be a team player… keep records of your payment history ready to share, when called upon. Also, make sure you cosigner knows that your payment may impact the amount they can qualify to borrow for the first year after closing, while you are working through that initial year of on-time payments.
Consider a contract
Your lender will hold you and your cosigner equally obligated on the loan, but you and your cosigner may want to consider making other arrangements — a cosigner agreement. Your agreement can be informal or you can engage an attorney to write one. Although your agreement will have no bearing on the lender’s rights, it can be enforced between you and your cosigner and is a great way to clarify expectations and establish an exit plan. A potential cosigner may even feel more comfortable signing on if you give them the option to track your payments or agree to set up an automatic debit.
Getting your cosigner off the hook
Your lender won’t mind if your cosigner to stays on the hook for the full term of your loan, but you and your cosigner may have other ideas. If there is a date by which your cosigner wants to be released from your loan, plan ahead.
Your lender can, with your help, run some “what-if” scenarios. Project your future income and debt and your lender can estimate when you should be eligible to qualify on your loan. The options for releasing your cosigner from the loan vary based on the type of loan.
FHA – Assumption
FHA loans permit an “assumption”. When you sell an assumption gives your buyer the option to assume responsibility for your existing loan, rather than applying for a new loan, but an assumption can be used to remove a cosigner too. You can apply to assume to take over the full obligation for your loan.
Applying for an assumption is like applying for any loan. An underwriter will review your income, asset and credit information and determine if you qualify for the loan on your own. When approved, the lender will give your cosigner a release of liability.
Because you are keeping the same loan, your existing loan, your existing interest rate and payment remain the same. FHA allows your servicer to charge “reasonable and customary” fees for processing an assumption — expect to pay around $1000.
Conforming – Refinance
Conforming and jumbo loans rarely allow an assumption. Instead, to release your cosigner from liability, you will need to refinance. This means paying off your old loan with an entirely new loan. You’ll pay a full set of new closing costs and will be subject to current market interest rates.
If you can lower your rate, get rid of mortgage insurance or accomplish other goals with a refinance, this could be a win-win (or win-win-win). But if current rates are higher than the rate on your old loan, releasing your cosigner from liability on the loan may come at the cost of a higher payment.
Should I buy with a cosigner?
If you learn that a cosigner will be needed to qualify for your purchase, think through the implications — interpersonal as well as financial. Talk with your potential cosigners and make sure everyone understands their role and obligations.
There’s a lot to consider, but leaning your options and talking through them will let you figure out if cosigning is the right path.
Start simple – call today!
If you’re excited about buying a home, but stuck because you think a cosigner may be needed, don’t overthink things. When considering a home purchase, your first move should always be meeting with a lender.
We’ll start by exploring loan options you qualify for on your own. We’ll only add a cosigner to the mix if we learn you need one. When your prospective cosigner has questions, you can put us in touch. I’ll answer questions and help you both get the information you need to make decisions.
Call, text or email today to get started: juleef@rate.com or 503-799-3711. Or apply online at www.rate.com/juleef.
I look forward to hearing from you!
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