Co-signer vs. co-borrowers
According to the Federal Housing Administration (FHA), a co-signer deal is distinct from a co-borrower deal.
In a co-signer deal, the lender examines the co-signer’s credit history, income and debt-to-income ratio, along with examining the same information from the homebuyer. The homebuyer becomes homeowner, holds title to the home and occupies it. The co-signer typically has no ownership interest in the property, and typically doesn’t occupy the home, but is just as liable for the loan as the homeowner.
Also, under FHA rules, the co-signer can’t be the seller, builder or an agent for the property.
With co-borrowers, the lender examines the credit history, income and debt-to-income ratio of both, both occupy the property and both are financially liable for the loan.
Why use a co-signer?
A common co-signing deal is a parent helping a child out of the nest and into their first home. A homebuyer may also need help co-signing if he or she is unable to meet all of the mortgage lender’s qualifying criteria in terms of income, credit, employment and other factors.
For example a homebuyer may need co-signing help when the homebuyer:
• Is a first-time homebuyer with little or no credit history.
• Has a low credit score.
• Has a high debt-to-income ratio, due to credit card balances or other outstanding loans.
• Wants to buy a house with a higher price for which he or she can’t qualify, because of limited income.
Who can co-sign?
Some lenders don’t limit who can co-sign for a mortgage. The FHA, however, says if the co-signer is a relative by blood, marriage or other legal means, the loan is processed like any other FHA loan with a down payment as low as 3.5 percent. If the co-signer is not related, however, the down payment for the loan increases to as much as 25 percent down.
Co-signing loan process
When a co-signer is part of the deal, the process is a co-process. Both the homebuyer and the co-signer complete the application and supply any required documentation. Typically, the co-signer will not be named on the title, but there are some exceptions.
Given the inherent risks for the co-signer, the loan can be written so that the co-signer gets a monthly statement and is notified if the borrower misses payments or otherwise faces problems.
Generally, the homeowner enjoys the advantages of a co-signed loan more so than the co-signer, but there are drawbacks.
Pros for the homeowner
• The home owner enjoys the ability to buy a home when otherwise that could have been impossible.
• While the loan carries both the names of the co-signer and the homeowner, the homeowner gets title to the deed.
• The homeowner benefits from tax deductions or other incentives to buy a home. Co-signers and homeowners should check with a tax professionals to understand all the tax ramifications.
• Paying on the mortgages gives the homeowner the opportunity to improve his or her credit score.
Cons for the homeowner
• The homeowner is under pressure to make payments on time all the time.
• Late and missed payments can affect the credit standing of both the co-signer and the homeowner. Late and missed payments and the resultant impact on credit standings could also cause a personal rift between the co-signer and homeowner.
Pros for the co-signer
• Co-signers enjoy the satisfaction of helping a loved one buy a home.
Cons for the co-signer
• The co-signer’s risks are significant because the co-signer essentially guarantees the loan. The co-signer is there because the mortgage lender does not have sufficient confidence in the homebuyer’s ability to honor the loan terms.
• If the homebuyer defaults on the loan for any reason, the lender can turn to the co-signer without investigating other options of collection.
• Co-signing a mortgage increases the co-signer’s debt-to-income ratio, as any loan would. In the future, if the co-signer needs a loan, say for a new car or a refinanced mortgage the co-signed debt burden could prevent approval.
With such a lopsided benefit-to risk-ratio, co-signers and homebuyers should fully understand their rights and responsibilities before entering into such an agreement.