In today's tight credit market, many borrowers are wondering if a co-signer might help them qualify for a mortgage loan. They can, but it's not a guarantee of success.
Co-signers on a home loan are generally helpful in cases where the primary borrower hasn't established a credit history, has irregular income or hasn't been in their current job for at least two years. They're less helpful in situations where the primary borrower has bad credit, because most lenders look at the lowest credit score when there are two borrowers listed on the application.
A co-signer is someone who agrees to take responsibility for a loan if the primary borrower is unable to pay. Usually a parent or other close relative, they have to have sufficient credit and income to be able to pay off the loan themselves if the primary borrower defaults.
Often used with limited credit, income history
Co-signers are most commonly used by young people whose parents are helping them get financially established. If the borrower is someone who previously hasn't made much use of credit, such as buying a car or using credit cards, banks will often accept having a co-signer with good credit back up the loan.
Another common situation is someone who's new in a job, is establishing a business, or who has income from a variety of irregular sources, some of which the bank won't count toward qualifying for a mortgage. Again, having a co-singer with a stable income and established credit can help.
In many cases, a lender may require that the primary borrower be able to actually qualify for the mortgage on their own, but adding a co-signer may enable them to obtain a lower interest rate or put up a smaller down payment than would have otherwise been required. In other cases, adding the co-signer's income may enable the primary borrower to obtain a larger loan than they could have on their own.
Not all lenders will allow co-signers on a mortgage loan - it varies from lender to lender. On FHA mortgages, the co-signer must be a parent or close blood relative; otherwise, a minimum 25 percent down payment is required.
Downsides for the co-signer
For the co-signer, the arrangement carries a lot of risk, and no small amount of inconvenience. For starters, they have to pay off the loan if the primary borrower defaults. There's no guarantee they'd get the property in return, unless that's specifically written into a side agreement.
In addition, being a co-signer on a loan reduces the credit you have available for your own purposes. If you want to buy a car, a vacation home or other major purpose, lenders will regard the debt you've co-signed for as part of your own debt load when evaluating how much you can borrow.
Obviously, you don't want to take on the risk of co-signing a mortgage unless you have a very strong reason to want to help the primary borrower, and are very certain they will handle their debt obligations in a responsible manner. The very fact that a borrower needs a co-signer in the first place means they're already at a higher risk of default, something to bear in mind before agreeing to co-sign a home loan.
As a co-signer, you're also stuck with responsibility for the loan until the mortgage is paid off or refinanced - you can't simply apply to have your name taken off the mortgage. You also can't strike an agreement where the borrower will refinance after so many years, since a lender may not approve a new loan.
For this reason, many parents or other close relatives chose other means of assistance rather than co-signing a mortgage. A cash gift to help with the down payment is one way of helping without compromising your own credit or binding you to future obligations.
If you have the financial means and credit standing, another alternative to co-signing is to buy the property yourself, then sell it to the person you'll be assisting under a land contract. This means the buyer doesn't have to deal with the bank at all - you're acting as their lender - and you're the only one who has to deal with the bank.
For the buyer, it works better than a rent-to-own arrangement, since they can still deduct the interest payments on their taxes. The deal can be structured with a balloon payment so that you have a fixed date when they have to refinance the loan under their own name, and you have title to the property in the event they can't make the payments.
Not all lenders will allow land contract arrangements on mortgages they issue, so be sure to get this cleared up beforehand. Once again, the advice of an experienced attorney is recommended before proceeding with such a deal, even with a close family member.