Mortgage Co-Signers and Co-Borrowers
Many young borrowers have little or no credit history, making it difficult to get student loans or mortgages–lenders generally take a cautious approach to first-time borrowers. Without a credit history to go on, it’s not unusual for them to require a co-signer before they hand over a check.
Agreeing to co-sign a loan or become a co-borrower on a loan can help someone without established credit (or good credit) get a student, auto, or home loan on their own. But co-signing or co-borrowing a serious loan is serious business. You could incur liability and risks and suffer serious financial consequences even if you know and trust the person who’s taking out the loan.
The Facts of Mortgage Requirements
For first-time home buyers, today’s tougher mortgage lending standards can be serious hurdles. Many don’t have a high enough credit score (the average for closed loans in August 2014 was 727) or enough income to meet the minimum debt-to-income ratio (DTI) lenders require (the DTI in August was 24/37, including the mortgage). To put this in perspective: just 61.1 percent of mortgage applications were approved in August.
In today’s economy, co-signing is more prevalent than ever–as much as 10 percent of borrowers need a co-signer to qualify for a loan. Some are desperate enough to advertise for one on Craigslist.
The Perils of Co-signing
As a co-signer, you aren’t just endorsing the borrower’s ability to pay back the loan. If the borrower defaults, you’re legally obligated to repay their debt, including the entire mortgage balance in the event of a mortgage default. And that’s not all:
- As soon as you become a co-signer, the debt will also show up on your credit reports. This can damage your score if the borrower misses a payment.
- Cosigning a loan can also affect your ability to get financing. Since a co-signer is legally obligated to pay the debt if the borrower defaults, the co-signed loan will count just the same as your own loans and gets factored into the your debt-to-income ratio if you apply for another loan.
- Should the borrower become delinquent in making payments on the loan, the bank or creditor can select which debtor to pursue. That means the lender can come after you before exhausting other means to get the money from the borrower.
Knowing the borrower and trusting him or her isn’t enough. For the first time on record, the delinquency rate on student loans has jumped above the rate for credit cards, car loans, or any other kind of consumer loan. As of September 2014, some 13.7 percent of outstanding student loans are in default, leaving millions of co-signers holding the bag.
Think about it this way: when you’re asked to co-sign a loan, you’re being asked to take a risk a professional lender has decided not to take.
Co-borrowing vs. Co-signing
In some ways, being a co-borrower is a better deal than being a co-signer. Co-borrowers get more benefits for basically the same risk.
First of all, co-borrowers receive direct benefits from the loan. Co-signing leaves you nothing but debt if the borrower fails to pay, but as a co-borrower, you share ownership of the home, the car, or the cash from the loan.
Another plus? Co-borrowers do more to help the primary borrower than co-signers. A co-borrower’s credit history, income, and assets are considered together with a primary borrower to qualify for a loan. Instead of qualifying individually, as co-signers are, the primary and co-borrower are able to combine their income and assets into one in order to meet the lender’s borrowing criteria.
Some Credit Score Caveats
However, credit scores from co-borrowers are considered separately when it comes to mortgages purchased by Fannie Mae and Freddie Mac (about half the nation’s mortgages). Lenders making conventional loans are required to focus on the lower of the two FICO scores.
On loans not purchased by Fannie or Freddie, the lender is likely to put more weight on the credit score of the person with the higher income. For some, it may be necessary to hold off on a home purchase for a few months to allow the co-borrower with credit issues to clean up his or her report and raise the score.
Should you be asked to co-sign or co-borrow, understand the financial risks you’re taking. Hard times can hit without warning, and you don’t want to be left with the bill. More than that, loans that go bad have a history of straining relationships. If you have reservations about the borrower’s ability to repay the loan, look into helping out in other ways.
Steve Cook is managing editor of Real Estate Economy Watch, which was recognized as one of the two best real estate news sites of 2011 by the National Association of Real Estate Editors. Before he co-founded REEW in 2007, he was vice president of public affairs for the National Association of Realtors. In 2006 and 2007, he was named one of the 100 most influential people in real estate.