What to Know Before You Co-Sign a Mortgage
When a close friend or family member asks you to co-sign a home loan, your first instinct may be to agree. After all, if you’re in the position to help, why not?
When done correctly, co-signing can be a great tool for helping someone who may have trouble qualifying for a mortgage on their own. However, before you sign on the dotted line, be sure you understand how this generous act could impact your own finances in the future.
What does it mean to co-sign?
Co-signers are necessary when a borrower is unable to qualify for a loan on his/her own for whatever reason – not enough income, poor credit score, lack of borrowing history, etc.
Denya Macaluso, vice president of residential lending for Michigan State University Federal Credit Union, says co-signing is a viable option for many potential borrowers.
“In recent years, student loans have been a major hurdle for young borrowers in obtaining mortgage loans, so having a parent co-sign is not uncommon,” she said. “But we’ve also seen the reverse situation where an adult child co-signs on a mortgage for an aging parent to help manage their finances and ensure payments are made on time.”
What are the risks of co-signing?
As a co-signer, you and the primary borrower are equally responsible for repaying the full amount of the loan. Should the primary borrower fail to meet their obligation, it’s your responsibility to pick up the slack. And depending on the circumstances, you may also owe penalties, late fees, additional interest, etc.
Macaluso says co-signers must also realize that this home loan will be part of their overall debt.
“If a parent co-signs on a mortgage for an adult son or daughter, and that mortgage has a $1,000 monthly payment, that $1,000 is not only considered part of the borrower’s monthly debt, but also the parent’s,” she said. “In some cases, this could prevent the parent from obtaining a loan in the future.”
It's important to note that some financial institutions may exclude the co-signed loan amount, if the parties can show a 12-month payment history that originated from the primary borrower’s account.
As far as credit, co-signing a loan has the same impact as any other type of debt. If the primary borrower consistently makes on-time payments, there should be a positive impact on the co-signer’s credit. However, if the primary borrower is late with their payments, it will have the same negative impact on the co-signer’s credit as it will for the primary borrower.
To protect yourself as a co-signer, The Federal Trade Commission provides several suggestions on its website, including asking the lender to agree, in writing, to notify you if the borrower misses a payment or if the terms on the loan change. The Commission also suggests that co-signers “get copies of all important papers, like the loan contract, the Truth-in-Lending Disclosure Statement, and warranties,” adding “these documents may come in handy if there's a dispute between the borrower and the seller.”
Macaluso says for those who are uncomfortable attaching their name to someone else’s debt, there may be other options available.
“You could give the borrower money to use for a larger down payment, or you could consider buying the home yourself and renting it out to the friend or family member until they are able to obtain a loan on their own,” she said.
Can someone be removed as a cosigner?
When you co-sign a mortgage, you are entering a long-term relationship. Lenders will likely be reluctant to remove you from the loan because that decreases their chances of being repaid if the primary borrower defaults.
“Most mortgage servicers will require the primary borrower to refinance the mortgage into his/her own name in order to remove the co-signer,” said Macaluso. “There are some institutions that may provide a release of liability in which the cosigner is released from their obligation. But for this to occur, the primary borrower typically needs to be current on the mortgage and qualify for the payment on their own.”
Because there is so much on the line, most experts say you should only become a co-signer for someone whom you completely trust. But even then, you may be wondering why someone would agree to take on this risk. Macaluso says when done responsibly, co-signing can work out well for both parties, even providing some benefits to the co-signer.
“You’re helping someone build equity in a home, which is an investment in their financial future,” she said. “That’s a generous act and should give you a great sense of pride.”
As with any large financial commitment, Macaluso says it’s wise to consult a financial advisor and/or an experienced, local lender to ensure you “understand the risks and the financial impacts and weigh all options available to you.”
For a list of local lenders, visit the Greater Lansing Association of REALTORS® website at www.lansing-realestate.com.