Housing inventory is painfully low in our region and home prices continue to climb in many neighborhoods. It’s a challenging market for first-time buyers and would-be buyers with financial constraints. Cosigning a mortgage is one option loved ones with the means and credit are increasingly considering.
Are you considering cosigning a mortgage for a family member or friend? While cosigning can help someone with limited credit or income qualify for a mortgage, knowing the potential implications on your own finances is important.
In this article, we'll look closer at the responsibilities of cosigning a mortgage and what you can expect.
The role of a cosigner in a mortgage loan
Cosigning a mortgage means assuming equal responsibility for the loan alongside the primary borrower. Simply put, you accept responsibility for making payments if the borrower falls behind or defaults on the loan—and become legally obligated to do so. Lenders typically require a cosigner when the primary borrower does not meet certain credit or income criteria.
Benefits and risks of cosigning a mortgage
Before deciding to cosign a mortgage, weigh the benefits and risks carefully. Consider the financial stability and responsibility of the borrower, as well as your ability to handle the potential consequences.
Cosigning a mortgage or other loan can enable a loved one or friend to obtain a mortgage or other financing otherwise unavailable due to their credit history or income. It’s a vote of confidence in the borrower’s future and can be a tremendous boost to that person’s long-term financial stability.
Cosigning a mortgage can also impact your finances negatively.
Impact on credit
As a cosigner, the mortgage loan will appear on your credit report. Any missed payments or defaults by the borrower will impact your credit score.
Debt-to-income ratio
Cosigning a mortgage increases your overall debt obligations, affecting your debt-to-income ratio. Remember, this is an essential factor lenders consider when evaluating your creditworthiness for future loans or credit.
Financial responsibility
If the borrower fails to make payments, you will be responsible for repaying the loan. Also, although a cosigner is listed as a cosigner on the loan, cosigners generally have no ownership rights to the property. So, if the borrower defaults, the cosigner can generally not force the borrower to sell the home. In addition, creditors are often permitted to collect for missed payments, penalties and fees from the cosigner before collecting from the borrower.
Difficulty obtaining new credit
Having an existing mortgage as a cosigner can make it more challenging for you to obtain new credit or loans. Lenders may view you as having a higher level of financial risk due to the additional obligations.
Be sure to have an open and honest conversation about expectations, financial capabilities, and potential risks before moving forward.
Qualifications and requirements for cosigners
Not everyone can be a cosigner for a mortgage. Lenders have specific qualifications and requirements for cosigners to ensure they are financially capable of assuming the responsibility.
Good credit: Lenders typically require cosigners to have a good credit score, usually above a certain threshold, as this demonstrates your ability to manage debt and repay loans responsibly.
Stable income: Lenders want to ensure that cosigners have a steady source of income to cover the mortgage payments if the primary borrower fails to do so. They may require proof of income, such as pay stubs or tax returns.
Debt-to-income ratio: Lenders consider the cosigner's existing debts when evaluating their ability to take on additional financial obligations. They typically have specific debt-to-income ratio requirements that must be met.
Legal age: Cosigners must be of legal age to enter into a legally binding contract.
Steps to take before cosigning a mortgage
Before cosigning a mortgage, here are some important steps to consider:
1. Understand the borrower's financial situation: Before agreeing to cosign, thoroughly evaluate the borrower's financial stability and ability to repay the loan. Review their credit history, income sources and expenses. If the borrower is asking you to be a cosigner, you have a right to the full disclosure of their finances.
2. Evaluate your financial situation: Assess your financial stability and ability to take on the additional responsibility of a mortgage loan. Consider your income, existing debts and long-term financial goals.
3. Consult with professionals: Seek advice from mortgage brokers, financial advisors or attorneys who can guide and help you understand the legal and financial implications of cosigning.
4. Review the loan terms and conditions: Carefully review the mortgage loan terms and conditions, including interest rates, payment schedules and any penalties or fees.
5. Have a contingency plan: Prepare for the worst-case scenario by discussing potential backup plans with the borrower. This could include setting aside emergency funds. You could also establish a plan or contract for selling the property under certain conditions.
Alternatives to cosigning a mortgage
1. Gift the funds: Instead of cosigning, consider gifting funds to the borrower to help them meet the down payment or qualify for a mortgage on their own.
2. Joint ownership: If you are comfortable with a higher level of involvement, consider purchasing the property jointly with the borrower. It’s one way to share the responsibilities and risks equally. Some mortgage programs allow for co-borrowers, where both parties are equally responsible for the loan. This differs from cosigning, as both individuals are primary borrowers.
3. Become a short-term landlord: Consider purchasing the home yourself and renting to the would-be borrower. He/she could sign a rent-to-own lease for three to five years. At the end of the lease, he/she could opt to buy the home from you for a specified price or formula based on current property values, allowing you to protect your financial interests and the borrower to obtain a mortgage when he/she can be approved without a cosigner.
The rent and sale price can be constructed to provide you with a reasonable return on your investment or make future home ownership more affordable for the borrower if you expect home prices to rise in your area. If the would-be borrower decides not to purchase, you can continue to rent or put the house on the market.
4. Ask a lender about special grants and mortgage programs for low and moderate income borrowers: There are federal programs for low to moderate income borrowers that may be better for you and the borrower to consider. Heritage Bank can help you explore those options and also explain our own offering: the Affordable H.O.M.E. program for borrowers who might otherwise not be able to afford a down payment or qualify for financing. Ask our mortgage loan officers about grants for qualified applicants.
Removing yourself as cosigner
It's important to consult with professionals, such as lenders or attorneys, to understand the steps and requirements for removing yourself as a cosigner. If you want to remove yourself as a cosigner, there are a few options to consider.
1. Refinance the mortgage: If the borrower's credit and financial situation are in good standing, they may be eligible to refinance the mortgage in their name only. This would remove your obligation as a cosigner.
2. Sell the property: If you and the borrower agree, selling the property can be a viable solution. The proceeds from the sale can be used to pay off the existing mortgage, thereby releasing you from your cosigner responsibilities.
3. Negotiate with the lender: In some cases, lenders may be willing to release you as a cosigner if the borrower can provide evidence of their ability to make payments independently. This may involve demonstrating a strong credit history, stable income and other qualifying factors.
For any questions about personal loans, mortgage and refinancing options, or other financial products, contact Heritage Bank or stop by one of our locations to speak with a banker.
