Helping out a friend or relative has got to be one of the best feelings in the world.
Whether it’s referring them for a new job, facilitating a conversation between them and a person of interest at the bar, or handing them a stick of gum in their time of need — it all comes with a certain feeling of satisfaction.
Now, one of the most impactful – but potentially complicated – ways you can lend a helping hand is by co-signing a mortgage loan.
You may be the difference between someone you care about being able to buy a home or not. But before you say yes, you should think long and hard about it.
If you end up co-signing, you’re assuming financial risk that could strain even the strongest of relationships.
What Is a Mortgage Co-Signer?
A mortgage co-signer signs a mortgage along with the borrower but doesn’t live in the home. The co-signer assumes financial responsibility if the primary mortgage holder can’t make their payments.
Think: backup quarterback — if something happens to the starter, it’s the backup’s responsibility to step in.
In the case of a mortgage, if the primary borrower can’t make payments on time and in full, the co-signer is legally obligated to cover their debt.
Who May Need a Co-Signer on Their Mortgage Application
If the borrower’s income or credit score doesn’t meet their lender’s requirements – a co-signer may be just what they need to purchase a home.
For prospective home buyers with low credit scores, inflated debt-to-income (DTI) ratios or limited credit histories, a co-signer can be a big help.
A mortgage lender’s primary objective is to assess the creditworthiness and financial risk of an applicant. As co-signer, you reduce financial risk to the lender and improve the borrower’s chances of qualifying for a home loan and/or getting a more favorable interest rate.
Making the Grade: 3 Primary Attributes of a Good Co-Signer
Unfortunately, not all co-signers are created equal.
Before agreeing to help out a friend or family member, consider the three attributes of an ideal co-signer:
- They have a good credit history and debt-to-income (DTI) ratio as well as a credit score of 670 or higher. A co-signer with a DTI of 36% or less will give the primary borrower the best chance of qualifying for a mortgage loan at a competitive interest rate.
- They can comfortably make the monthly mortgage payments in case the primary borrower defaults. Defaulting is a very real risk. Not having the resources to make payments could send a co-signer into a financial tailspin.
- They are not planning on applying for a large personal loan in the near future. Co-signing increases your DTI. A higher DTI will make it difficult for the co-signer to qualify for a loan they are applying for.
Differences Between a Co-Signer and a Co-Borrower
They have similar titles and similar obligations and responsibilities when it comes to mortgage loan repayment. But there is one key difference between co-signers and co-borrowers: ownership.
A co-signer has no title rights to the property being purchased – a co-borrower does.
Signing on: The Mortgage Co-Signing Process
When you co-sign a mortgage, your finances will be assessed the same way they would be if you were the one applying for the loan.
To determine if the primary applicant qualifies for the loan, and at what interest rate, lenders will examine your credit score, DTI ratio, job history and more (as well as the primary applicant’s).
Being prepared for a financial deep dive can save everyone’s time, and it shows lenders that you are serious about the application.
Documentation you may need to provide
Before beginning the mortgage application process as a co-signer, it’s important to be as prepared as possible. Here is some of the paperwork you could be asked to provide:
- Pay stubs
- Tax returns
- Verification of employment (VOE) letter
- Bank statements
Pros and Cons of Co-Signing a Mortgage
The positive side of getting a co-signer is pretty obvious for the primary borrower — it can boost their chances of qualifying for a mortgage and getting a lower interest rate.
But for a co-signer, the picture is a little more abstract.
Let’s take a look at some of the benefits and drawbacks of co-signing a home loan.
|It helps a friend or relative qualify for a mortgage and/or get a better interest rate.||You are legally responsible for the mortgage if the borrower can’t pay.|
|It can diversify your credit portfolio (which may boost your credit score).||The debt will increase your DTI ratio, limiting your ability to qualify for a loan of your own.|
|On-time payments can improve your credit score.||Missed or late payments will negatively impact your credit score.|
Considering the weight of the cons, your confidence in the primary borrower is essential.
Have an open and honest conversation with your friend or family member about their finances and their ability to pay back the loan before you agree to sign on.
Alternative Options To Secure a Mortgage
Agreeing to co-sign a mortgage is a major commitment — and one that may not be worth the potential risk.
Luckily, it’s not the only option for prospective home buyers in a less-than-ideal financial situation.
Before agreeing to co-sign, make sure the primary loan applicant has considered alternative loan options.
Let’s review some alternatives designed for low- to moderate-income home buyers:
|Loan Type||How It Can Help|
|Federal Housing Administration (FHA) Loan||3.5% minimum down payment
Minimum credit score of 580
|Fannie Mae HomeReady®||3% minimum down payment
Minimum credit score of 620
No income limit for first-time home buyers
|Housing Finance Agency/Authority (HFA) Loan||3% minimum down payment
Minimum credit score of 620
Income limits vary by state
The alternatives don’t end with the three we’ve listed here. There are multiple loan options out there to help someone purchase a home.
Be Aware of What You’re (Co-) Signing Up For
Deciding to co-sign a mortgage for a friend or relative can have a profound impact on their life. But it can also have a profound impact on your finances.
Know, understand and be at peace with the risks you’re assuming. Provide your friend or relative with alternative home loan options. It is essential that you make an informed decision before you sign on the dotted line.