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What to Know Before Co-Signing on a Mortgage

September 16, 2016
Mortgage Process, Mortgages
What to Know Before Cosigning on a Mortgage
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Say a close friend or family member doesn’t have a strong enough credit score to qualify for a mortgage, and you want to step in with your own shining score to give her some borrowing leverage. No matter how well-meaning your intentions, you’ll want to proceed with caution when it comes to co-signing on a mortgage — and perhaps consider some alternatives.

Co-signing on a mortgage is a serious decision, one that can rattle your sturdy credit history and make you responsible for monthly payments if the borrower misses a payment or, worse, defaults.

Before jumping into the mortgage process with a friend or family member, keep in mind the following.

You are essentially a borrower

Grant Botma, founder of Stewardship Mortgage in Gilbert, Arizona, says that in the eyes of the lender, there is no “co-signer.”

“Everyone is a borrower,” he says.

As a co-signer, you’ll be “subject to the same underwriting guidelines and the same scrutiny of underwriting as the primary borrower,” Botma says. Be prepared to have your credit pulled, to present documentation of your finances, and to fill out a lot of paperwork.

Because it’s like you’re taking out a loan of your own, co-signing can affect your ability to take out another loan down the road — be it a personal, car or mortgage loan. Qualifying for a loan requires a good debt-to-income ratio, and the loan you co-sign for is considered part of your debt.

You are essentially an owner, too

Even if you’re not living with the primary borrower in the home, you still might have an insurable liability for what goes on inside.

Botma says that in most states “the lender will initially create the loan and title documents to show all borrowers — co-signers and all — on the note and title documents.” But after the loan is funded and ready to go, you have the right to change how the property is titled.

If you remain on the title, make sure the insurance policy on the home is sufficient.

A lot of trust is involved

Can you fully trust that the person you’re co-signing for will make all his mortgage payments on time and in full?

Tim Clark, a senior loan consultant with Summit Funding Inc. in Sacramento, California, says that one missed mortgage payment can drop your credit score by more than 100 points.

Before you commit to a loan, sit down with the borrower, go over his financial history and make sure he understands how important it is to stay current on mortgage payments.

Some alternatives to co-signing

Co-signing on a mortgage isn’t necessarily the only way you can help someone on the path to homeownership. Here are some other options:

You can gift your friend or loved one money, which he can put toward personal debts or the down payment for a home.

“A gift is so much cleaner, and will protect your relationship so much better than co-signing,” says Philip Olson, a certified financial planner and founder of The Art of Finance in Austin, Texas.

“I can’t even count the number of times I’ve heard someone talk about a ruined friendship or a ruined relative relationship because they got into debt with somebody else — and that’s what co-signing is.”

Keep in mind, though, that there’s a limit to how much money family members can gift one another before it’s considered taxable income to the receiver.

The borrower can try to improve his credit score, increase his income and save money.

Depending on how low the person’s credit score is, or how much debt he has, it might be wise for the intended borrower to improve his finances before buying a home. That way he’ll not only let you off the hook, he’ll be able to qualify for a better interest rate when he finally applies for a loan.

Olson suggests helping someone who doesn’t have a credit score — say a relative who’s fresh out of college — build one up by helping her get a secured credit card or a low line of credit.

How to get your name off a loan you already co-signed

Olson suggests that if you’ve already co-signed with a friend or family member, it’s best to work toward getting your name off of the loan.

“Very often folks will co-sign on a mortgage, eight years will go by, Mom and Dad are still on the note, and they don’t need to be anymore because the borrower’s credit score is good from paying the mortgage for so many years,” Olson says.

Paying off the loan is the only way to release a co-signer. Since that could take decades, refinancing is the quickest way to get your name off the loan.

Once the primary borrower is on solid financial footing with a low debt-to-income ratio, high credit score and steady income, he can likely refinance at a lower rate, freeing you of your co-signer responsibilities.

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Michael Burge is a staff writer at NerdWallet, a personal finance website. Email: mburge@nerdwallet.com