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When a homebuyer needs a mortgage but has poor credit, one option is to find a close friend or family member with good credit willing to become a co-signer on the loan. This can be very helpful for the buyer who can’t meet the financial qualifications for a conventional loan. However, for the co-signer, there are many reasons to be wary of such an arrangement.
Here, we look at what borrowers and co-signers need to know before entering a co-signing agreement and the alternatives that should be considered.
What Does It Mean to Be a Co-Signer on a Mortgage?
Borrowers with poor credit or a high level of debt can have trouble securing a mortgage on good terms. One option they have is to find a co-signer with good credit that can share the responsibility for repaying the loan. This provides security for the lender against default as the co-signer effectively agrees to step in and cover any payments the original borrower cannot make in time. Most lenders will typically consider the ideal co-signer to be someone with a credit score of 670 or higher and a debt-to-income ratio under 43 percent.
One important distinction to make is the difference between co-signing a co-borrowing. From a lender’s perspective, the two terms are synonymous, but from a legal perspective, there is a big difference.
For instance, co-borrowers will appear on the property’s title, meaning they will have certain rights and responsibilities over the property. Co-borrowers are also expected to contribute toward mortgage payments even when the original borrower is not at risk of default. By contrast, co-signers do not have any rights or responsibilities to the property covered by the loan. The co-signer’s only legal responsibility is toward the loan when there is a risk of default.
Benefits of Co-signing
Becoming a co-signer can be incredibly rewarding to help someone you know get a fresh start, especially if they’re recovering from a rough financial patch or are just getting started on their own. Many parents become co-signers for a financially reliable child who hasn’t yet built up a strong credit history. Co-signers may also see a bump in their credit score once the loan is paid off, though, admittedly, not by much if their credit score was already pretty high.
For the original borrower, getting a co-signer should help them secure a more affordable interest rate and better repayment terms overall. Having a co-signer can also be especially helpful for building or rebuilding a strong credit history after a bankruptcy.
Risks of Co-Signing
Benefits aside, becoming a co-signer will mean taking on considerable risk. If the original borrower cannot make their monthly payments at any time, then the co-signer must step in and assume that responsibility. Failure to meet these payments will hurt your credit history and score and may even lead to a lawsuit that forces repayment by garnishing your wages.
Other issues remain even when a co-signer is confident that they can cover the loan. For instance, taking on a new loan, especially a large one like a mortgage, will hurt your debt-to-income ratio. This can make it very difficult to take out another large loan in the future for, say, a new car or retirement home.
Lastly, there’s the issue for both parties of how their relationship might be affected by a co-signing agreement. There may be a lot of difficult conversations in the future about money that will test even the strongest relationship. Both sides need to be aware and ready for that possibility.
Alternatives to Co-Signing
There are alternatives that borrowers should consider before asking someone to co-sign their mortgage. For instance:
- Homebuyer Assistance Programs – There are dozens of homebuyer assistance programs available at the federal and state levels that can help buyers get their foot in the door. Most are specifically geared toward first-time buyers, but there are also other government-backed options like an FHA or VA loan.
- Find a Cheaper Home – Always be on the lookout for other properties that are in a more affordable price range. A cheaper home will mean a smaller loan. It may also make sense to wait a bit longer before buying until you’ve built up a stronger credit history and a larger down payment.
- Cash Gift – Having a family member or close friend provide a cash gift can allow borrowers to raise their down payment and, hopefully, reduce their monthly payments enough that they don’t need a co-signer. To provide a cash gift, the donor must sign a gift letter stating they are not anticipating any reimbursement.
Final Thoughts
Co-signing someone’s mortgage will mean taking on responsibility for repaying it, which is not a decision that should be taken lightly. Both parties should discuss the issue in detail, consider alternatives and if they choose to go ahead with a co-signing agreement, make a plan for how they will communicate about the loan.
Co-signing is just one of several options that borrowers with shaky finances have for securing a loan, and while it may work for some parties, it’s certainly not for everyone.
