by Kevin Mercadante
February 24, 2018
by Kevin Mercadante
February 24, 2018
If your mortgage application is a little bit weak, and you're having difficulty getting approved, adding a cosigner to your mortgage could save the day.
It won't work in all situations, but it does in most. It's a common arrangement, particularly with first-time homebuyers, who may have fair credit and/or a less than perfect employment record.
A cosigner is someone who goes on a mortgage application with primary borrowers who are not fully qualified for the loan on their own. The cosigner may be necessary to shore up weaknesses in the primary borrower's profile. This includes the debt and income situation, as well as credit. The addition of the cosigner makes the loan application more attractive to the mortgage lender.
Generally speaking, a cosigner will be on the loan documents, such as the note and the mortgage and deed of trust. The cosigner will not be on title to the property, and will not sign the deed. The cosigner's role is strictly on the loan application, and not with ownership of the property.
To be eligible, a cosigner must have a family relationship with the primary borrower. This includes a parent, grandparent, sibling, aunt or uncle. But it can also be a "family type relationship". This can include someone with whom you have a close, long-term relationship very similar to that of a family member.
The purpose of this restriction is to eliminate the possibility of a cosigner being a someone with an interest in selling the property. That includes a real estate agent, builder, or even a mortgage broker. Each would stand to gain if your loan application is approved, and are therefore ineligible.
The cosigner must be a US citizen or resident alien. Lenders may also require that the cosigner live in the same state as the primary borrower and the property being purchased. This will happen if state law would make it difficult or impossible to pursue an out-of-state cosigner in the event of default.
Mortgage lenders underwrite loans according to various matrices. There are different levels of criteria in each category. This includes loan-to-value (LTV) ratio, debt-to-income (DTI) ratio and credit score ranges. It's a fairly complex process only understood by industry insiders.
But it works something like this…
A lender might approve a mortgage with an 80 percent LTV, a 720 credit score, and a 42 percent DTI (this DTI exceeds the 36 percent guideline).
But let's say a borrower has a 42 percent DTI, a 95 percent LTV, a credit score of 625, and no history of ever having paid a monthly housing expense. This borrower is weak in all three categories and cannot demonstrate the ability to manage a house payment. The lender might not approve the loan.
The alternative would be to add a cosigner to the loan. If the cosigner has good or excellent credit and a low personal DTI, they will add sufficient strength to the primary borrower's loan application to get it approved.
The addition of the cosigner provides the mortgage lender with an extra level of security if the primary borrower is unable to make the payments. The cosigner will presumably step in and make the payments until the primary borrower gets back on his feet. But if the primary borrower allows the mortgage to go into default, the lender can pursue remedies from the cosigner.
While a cosigner can shore up limited weaknesses in a primary borrower's loan application, there's a limit to what adding one can do.
Here are three categories where the effect of adding a cosigner is limited or not beneficial at all:
The fact that you're adding a cosigner to your loan does not make a down payment requirement go away.
According to the most recent guidelines from the Federal National Mortgage Association (or "Fannie Mae")—the loan-to-value ratio on the property being purchased cannot exceed 95 percent. That means that a five percent down payment will be necessary.
Fannie Mae regulations require that the five percent down payment comes out of the occupying borrower's funds. The cosigner is free to increase the amount of the down payment, but the minimum requirement must be paid by the occupying borrower(s).
Although a cosigner's income can be used to help you qualify for the mortgage, lenders impose a maximum DTI of 43 percent on the occupying borrower(s).
DTI is calculated by adding recurring non-housing debts to the new monthly house payment. This includes payments on car loans, credit cards, installment loans, and student loan debts. It will also include monthly payments for child support and alimony, if those are required.
Adding a cosigner can help on the income side but it's not a solution in all cases. If you as the occupying borrower will have a DTI of 57 percent, the cosigner arrangement will not help. That's true even if adding the cosigner drops the DTI to 30 percent. The lender will judge that you will be overextended on the house payment and your non-housing obligations.
Adding a cosigner to your mortgage won't help your situation if you have poor credit. While a cosigner helps in several categories, including credit, it does not erase bad credit.
The minimum credit score for a conventional mortgage is 620. For an FHA mortgage it's 580, though you can go below 580 with a down payment of 10 percent or more. If the primary borrower's credit score is lower than these minimums, a cosigner won't help. The same is true if the primary borrower has a recent bankruptcy or foreclosure.
While most people tend to think of cosigning a mortgage as a relatively casual arrangement, it has serious potential risks. It's more than just "doing a favor for a family member or friend".
Cosigning the mortgage is not a one-off event. The cosigner will remain legally part of the mortgage until it is paid off. This arrangement could impair the cosigner's ability to obtain credit in the future. The additional obligation will appear on the cosigner's credit report, and may be counted as a liability against the cosigner by a future lender.
Late payments made by the primary borrowers are reflected on the cosigner's credit report. These will of course damage the cosigner's credit score. A pattern of late payments could severely impact the cosigner's credit score.
And finally, should the primary borrowers default on the mortgage, the lender will pursue the cosigner to satisfy the loan. The cosigner may have to come up with money from their own personal assets to do this since they don't usually hold title to the subject property.
Because of the risks that the cosigner accepts from the arrangement, it's up to the primary borrowers to protect the cosigner's interests.
The most obvious is to make all payments on time. It's not just the primary borrower's credit that needs to be protected, but the cosigner's as well. Since cosigning the mortgage is an act of kindness, the credit obligation should never be taken lightly.
The primary borrowers should also actively pursue removing the cosigner from the mortgage as soon as possible. There is generally no provision for a cosigner release from an existing mortgage. The only way to do that is to refinance the original mortgage.
This is usually possible once the primary borrowers have been in the home for at least two years. At that point—if they've made all their monthly payments on time—their credit profile has improved to the point where they can be approved without a cosigner.
If you're the primary borrower, you should make every effort to refinance the loan within that timeframe. The cosigner will have done you a major favor by enabling you to buy a home that you otherwise wouldn't be able to afford.
Having a co-signer on your mortgage can help your less than perfect application get by. But it's not the answer to everything, and it shouldn't be taken lightly. Make sure you both fulfill the mortgage requirements before signing.