Cosigning On A Home Loan – Why You Should Rethink That

Learn all about cosigning, what does it mean to cosign a loan application, should you do it and how you can get out of it.

Cosigning is the process by which another person shares the responsibility for paying off somebody else’s debt obligation in the event that the primary party defaults on the payment.

The economic crisis of the year 2007-2008 battered the credit scores of many borrowers. At the same time the requirement by lenders regarding the credit rating increased and became more strict.

The result was that many borrowers required and needed someone with a good credit rating to sign on their loan application in order to be qualified. This person was to be someone who is willing to share the responsibility and expressed his intent to come through with the payment if the primary party went into default. However, finding cosigners for loan applications is not the easiest thing. In fact, mortgage loans are the kind where you will see the least amount of cosigners.

Cosigning provides limited help on a mortgage loan application

As already mentioned cosigners are rare on a home loan application. Even if the borrower who cannot qualify for a home loan on his own account finds a person to cosign the lender will still look at the credit rating of the person who is applying for the loan. They will not use the credit of the cosigner. While the cosigner cannot improve the credit score used to price the loan the cosigner’s income may be added to the borrowers income in determining the size of the loan for which the borrower qualifies.

On FHA loans hundred percent of the cosigners income can be used to raise the qualifying loan amount up to the FHA loan limit. However the cosigner’s debt is also added in determining the qualifying loan amount. This means a cosigners with a large debt could add little or nothing to the qualifying loan amount.

On conventional loans which are essentially non-FHA and non-VA loans, non-occupant cosigners are not allowed at all. Those that do allow it limit the incremental income to 50% of the cosigner’s income but they include hundred percent of the cosigner’s debt. As a result there are not many cosigners on conventional loans.

The reasons why cosigners are not there on mortgage loans is that this is a very serious responsibility to undertake and apart from somebody like a parent who is trying to help out their child with the first loan, no one else will be ready to take on this burden. 

It has been known for cosigners to suffer and have their lives seriously disrupted if the primary borrower missed a payment or stopped making payments all together. Usually people realize all too late that they should not have cosigned on a loan application.

It should be clearly understood that the lender has all rights to collect from the cosigner if the primary party defaults on a payment. In fact the lender can straightaway try to recover the money from the cosigner without trying to recover from the primary party as both are legally responsible. This is prohibited in some states where the lender is first supposed to try to recover the money from the primary borrower. Check this law in your state with an attorney if you are considering becoming a cosigner for someone.

Cosigning for Someone You Know Extremely Well

Cosigning does not always necessarily have to be a negative experience for the person. Sometimes a person cosigns for another person because they have information about the person that the lender does not. Parents cosigning for the children to help them establish their first credit is common.

Many of these situations have a happy ending. However, it must be kept in consideration there are also circumstances in life which could prevent the primary party to be unable to pay on the loan no matter how noble the intent or character of the person be.  Such circumstances include but are not limited to sudden and serious illness or job loss. In such a case the cosigner will have to take responsibility for making the payment on the loan. Such a risk with cosigning on a loan application is something that cannot be avoided.

Cosigning for Somebody Who Is Not Responsible

This is the single biggest mistake that a person can make when considering to cosign for a person. Usually people only cosign for a person whom they know extremely well and whom they have great faith in.

They also cosign for the reason that the person could be getting denied for a loan that has nothing to do with the financial situation of that person. Just because a person has a poor credit rating or a lack of credit history doesn’t mean the person does not have the resources for paying off the loan.

If you know a person and you know the person to be responsible who will follow through on his commitments then cosigning could be an all right thing to do. In fact most of the cosigning instance between family such as parents and children have an happy ending. However, it also stands that just because a person has the resources to pay the loan does not mean that he will.

The biggest mistake that you can make is when you end up cosigning for somebody who you did not know that well and about whom you had no information regarding his/her capacity or the willingness to repay the loan.

If you end up cosigning because you get taken up by the distress of the person or the persuasiveness of the person without really contemplating the practicality of the whole situation then you could be in for trouble. In fact most of the disasters that happen from having cosigned on loan application happens for these reasons. People cosign when there is no evidence to suggest that the borrower is reliable and has the resources to repay the loan in the future.

People get taken in by strong feelings of obligation to help relative, friend or a lover. The guilt of refusing along with the fear that the refusal would impact a relationship overwhelms better judgment. As everyone will know it is hard to say no to someone near and dear. But if you have reason to suspect that the cosigning is not a good idea then go through with your instinct. Because if the person does happen to default it will affect the relationship anyway.

If you’re not fully confident that absent unusual circumstances the borrower will meet his or her loan obligations you should say a firm and definite no to cosigning a loan application. If the person chooses to end the relationship because of this then there is nothing you can do about it.

But saying yes to such a person means jeopardizing your financial security and that of your family is really not worth the risk

How Can You Get out of a Cosigning Obligation

The truth is once you have co-signed on a loan application you cannot be taken off it till the loan is repaid by you or by the borrower. If the primary borrower has defaulted then the lender has no reason to take you off the list because he has you there for this very reason in the first place. The lender needed you to cosign to safeguard himself against the very eventuality that the primary borrower will default on the payment. Now he has you to recover the loan from. So you have no option but to either pay off the debt to end the obligation or get the primary borrower to pay it off. Apart from that there is nothing much you can.

Cosigning Can Affect Your Qualification for Loan

Being a cosigner on somebody else’s loan or mortgage can impact your own ability to get a loan yourself. This is because the other person’s loan will show as an existing liability on your credit report. Since you are already responsible to pay off one mortgage loan, your ability to take on a second mortgage loan will be tremendously hindered in the eyes of the lender.

However, if the primary party has been making regular payments on the existing loan for a certain period of time, you may be able to provide documentation to the lender proving this fact. In this case the lender to whom you’re applying for a loan yourself may be willing to overlook your current obligation. It will not remove your obligation from the loan contract from the other party or from your credit file but with an understanding lender you might be able to get a mortgage of your own and qualify for a loan amount of the sum that you want.

Cosigning for the Lease Contract

The only difference between cosigning for a house purchase and a lease is that your obligation is likely to be shorter.

Things To Know If You Are Cosigning On A Home Loan

Co-Borrowers are people who have signed together on the contract note and are held equally responsible for paying back the loan.

Having a co-borrower on a loan can make things easier and at the same time can be a source of a lot of complications at the time of taking the markets as well as later.

When one co-borrower has a better credit than the other

When one of the borrowers has a better credit than the other it might interfere with the prospects of getting the mortgage loan at good interest rates. The good credit borrower may be able to get the mortgage at a lower interest rate but the presence of bad credit borrower will raise the interest rates.

One way to deal with this situation is to have only the good credit borrowers apply for the loan. But then the issue arises as to whether just one borrower can qualify for the amount that will be enough to purchase the home that he has in mind. Lenders typically like to have more than one borrower responsible for the loan in order to safeguard their investment. Having just one borrower apply for the loan will limit the loan to the income potential of that particular borrower.

Before the financial crisis it was quite common for a single person with good credit to buy of home using a program that did not require verification of information. But ever since the real estate meltdown full documentation has become the rule and programs that support incomplete documentation or unverified income are not in practice anymore. Another possibility is to have a third-party with good credit signed on the mortgage loan application but then there are very few people who are willing to undergo this role with the exception of parents.

Problems with Mortgage When Co-Borrowers Split

As mentioned before having a co-borrower was on a mortgage loan makes the process simpler and easier in certain respects it can also lead to a lot of complications in the future when the co-borrowers happen to split regardless of whether they were married or not. However more difficulties could arise with an unmarried couple because unmarried couples tend to purchase a house more recklessly. When the couple splits there are issues at hand that should have been dealt with before but usually are not. These issues prevent a clean and amicable separation.

These are some of the issues that you should resolve with your partner before you make approaches on the home.

Read what problems can arise when co-borrowers a mortgage part ways and how to deal with them.

Problems With Mortgage When Co-Borrowers Split

Problems can arise when co-borrowers on a mortgage loan split, regardless of whether they were a married couple or not. This is what can happen and how to deal with a situation where co-borrowers on a mortgage loan are parting ways.

Split with Sale of the Home

If the partners can reach an agreement that in case there is a split in the relationship in the future the house must be sold and the proceeds to be divided amongst themselves in a certain ratio then it can save a lot of problems. It helps avoid a lot of complicated issues especially if one partner decides to stay in the house.

If the split in the relationship leads to a sale of the house the only concerned issue is how to divide the proceeds. Equal shared may or may not be fair.

A partner who makes the mortgage payments or has paid a large part of the down payment should be entitled to a larger share of the proceeds. One approach is to divide the net proceeds by each partner’s contribution to the equity in the house when it is sold. For example if two people pay $100,000 for a house, take a mortgage of $80,000, pay $20,000 down payment plus $3000 in settlement costs and sell it after five years and the loan balance is $74,000 the total contribution of the partners in the equity at the time of the sale consists of $23,000 in cash at purchase plus $6000 in reducing the loan balance. If one part that contributed 60% of the cash and paid for the expense that partner’s share of net proceeds would be 56%.

In certain cases this scenario is not fair because one of the partners might have put in more work in improving the house.

The point is that whatever the expected scenario or role of each of the partners is in buying or keeping the house, some sort of an agreement should be reached beforehand in anticipation of such a scenario which will save  both of them a lot of trouble in the future.

Split With one Partner Continuing to Stay in the House

The terms of settlement can be more complex if one of the partners is going to be staying back in the house. Since there is no sale the partners must agree on an appraisal procedure and who would pay for it. They should also decide whether real estate sales commission should be ducted from the valuation used in the settlement. Another problem arises if the part remaining in the house doesn’t have the money to pay off the partner who is leaving. The more the developed equity in the house more the partner who is staying back needs to come up with in terms of cash to pay off the partner who is leaving. A home equity loan is not possible unless both partners become responsible which is not something the departing partner will agree to. However, the largest hurdle may come in the way of the departing partner being still responsible for the mortgage loan on the home even though he is no longer staying in it.

Many people who seperate from relationship and leave the home believe that they are no longer responsible. Sometimes this has to do with the fact that an agreement was reached between the two partners and even the respective lawyers. The only problem is that till the time the lender is taken into this agreement and he agrees to take off name of the second partner, he can always hold that partner liable for the mortgage loans. As long as the name of the departing partner remains on the mortgage contract it will interfere with his ability to qualify for a future home loans because the existing homeowner will show as an existing liability.

Lenders have no incentive to remove co-borrowers from our homegrown. As mentioned before they like to have more than one people as responsible to pay off the loan as they like to safeguard their own investment. Some lenders could be induced to do this if it was proved that the partner staying back in the house was the one responsible for making the payments on the mortgage in the past and has done so with a perfect payment record. Even then this sort of procedure takes a long time and easily up to a year.

If the lender refuses to take of the name of the departing partner, the only other recourse open is that the remaining partner refinances the mortgage in his or her own name. This poses a difficulty on its own because re-financing with a single name could be difficult and may result in higher interest charges which is something the remaining partner might not want to do. It will be of great convenience to all parties concerned if agreement about all of these issues could be reached before a situation can arise. If there is no agreement then the house must be sold and the mortgage paid off.