June 29, 2018
June 29, 2018
If you are looking to purchase a home and you’re having difficulty qualifying for a mortgage, you may be able to improve your chances by adding a cosigner to the loan application. Though it will not enable you to purchase a property that you clearly cannot afford, a strong cosigner can enable you to be approved for a mortgage even if your credit or income are a little bit weak.
A mortgage cosigner is someone who is added to the loan with the borrower(s), usually due to the fact that the borrowers cannot qualify based on their own financial strength. The cosigner may be added to the loan in order to compensate for either insufficient income, or a weak credit history. A lender may be persuaded to approve a mortgage for borrowers based on the strength that a cosigner brings to the loan.
A cosigner is most typically a non-occupant borrower. Their income and credit give strength to the loan, but they do not live in the property. However they will be included on the mortgage note, as a fully responsible party. They are also generally an owner of the property being purchased. As such, cosigner must also sign either the mortgage or the deed of trust.
The cosigner is usually a relative of one of the occupying borrower’s. This can include a parent, sibling, grandparent, aunt or uncle. It can also include someone with whom you have a family type relationship, however, that relationship will need to be carefully documented.
A cosigner cannot be someone who has a specific interest in the sale of the property. That would include the property seller, the builder, or a real estate broker. From a business perspective, adding a cosigner must be entirely an arm’s length transaction.
While mortgage lenders will accept cosigners on most types of loans, there are specific requirements that will apply. While the cosigners income and credit will be used to help qualify the occupying borrowers for the loan, the occupying borrowers must generally make a down payment of at least 5% of the purchase price out of their own funds. However, this qualification will usually be waived if a total down payment of equal to 20% of the purchase price is involved.
Generally speaking, the occupying borrowers must be able to qualify for the monthly house payment even apart from the cosigners income. For example, the occupying borrower’s maximum debt to income ratio (DTI) cannot exceed 43% of their income.
DTI is calculated by dividing the new house payment, plus the occupying borrower’s monthly long-term debt, divided by the occupying borrower’s stable monthly income.
As a rule, mortgage lenders prefer when the DTI does not exceed 36% (though they often exceed it). But that will be the expectation when the cosigners income and credit are added to the calculation.
For this reason, the cosigner added to the loan cannot be someone who merely has outstanding credit. The cosigner will have to bring both high income and low debt into the picture. This will be especially important since the cosigners primary monthly house payment will also be added to the DTI calculation.
Generally speaking, if a cosigner is added to a loan, the maximum loan-to-value ratio (LTV) is 90%. (This is the amount of the new mortgage, divided by the purchase price of the home). Another way to look at it is that a 10% down payment will be required if a cosigner is used.
However, if the loan is underwritten through what is known as automated underwriting, the LTV can be as high as 95% (5% down payment required).
The 90% and 95% maximum LTV limits will also apply in the event that a second mortgage is used to make the purchase. For example, if the borrowers wish to avoid private mortgage insurance (PMI) they may take a second mortgage or home equity line of credit that will lower the LTV of the first mortgage to 80%. However, even using that strategy, the maximum first/second combination will still be limited to either 90% or 95%.
When a cosigner is added to a mortgage, it’s important that the occupying borrowers and especially the cosigner be aware of the responsibilities involved. So many times a cosigner situation is viewed as an almost casual arrangement, but the reality is quite different.
The cosigner is lending his creditworthiness to the loan. If the occupying borrowers make one or more late payments on the loan, that information will be reported on the cosigner’s credit report, as well as that of the occupying borrowers.
Even more important, should the occupying borrower’s default on the mortgage, this will be a credit strike against cosigner as well.
Though both situations may seem somewhat unfair – after all, it isn’t actually the cosigner who makes the late payments or defaults on the loan. But the cosigners addition to the loan is the entire reason why the mortgage lender approved the loan in the first place.
Beyond credit implications, the cosigner could be required to make good on the loan if the occupying borrowers default. This could include having to pay a deficiency balance on the mortgage if the property is sold for less than the amount owed on it.
As an occupying borrower, you should make every effort to protect both the cosigner’s credit rating and her financial resources.
A strong cosigner can make all of the difference in whether or not your mortgage is approved. But think carefully about the implications for both the occupying borrowers in the cosigner.