Today's topic concerns adding a co-borrower to a loan. It is a question that comes up fairly frequently, particularly when one party has credit that isn't good enough to qualify for a mortgage loan.
There are a couple of types of co-borrowing situations. The most common is a husband and wife who are buying a home together. Typically they are buying the home for a residence. As long as credit, income and debt ratios are within scope this type of loan will be processed and approved as a matter of course.
The questions I receive about co-borrowing are typically when someone attempts to qualify for mortgage financing and discovers one of two things:
1) His or her credit isn't good enough to qualify
2) His or her income isn't enough to qualify for what they wish to buy
I will tackle the second question first- and the decision that must be made has everything to do with the rules set forth by FHA and Fannie Mae. Often parents wish to assist their children by co-signing for a mortgage loan-particularly if income or debt ratio is an issue. In this scenario, we are assuming good credit on the part of both parties. There are two options and the choice has to do with down payment. Fannie Mae the overseer of conventional lending does not recognize a co-borrower that is not going to occupy a property. Therefore, if someone wants to use a conventional mortgage to purchase a property for their child the property is defined as an investment property-even if the child is living there, in title, and paying the mortgage on their own. An investment property requires a minimum of 20% down payment. Lending fees and or interest rates are higher for an investment property than a primary property as well. So this may not be a palatable or feasible option. (And if you are thinking you will say that both parties are living in the property when that is not the case-think again. Not telling the truth about occupancy is loan fraud, which is a federal offense and the penalties are severe.)
That leaves us with the second option which is the FHA option. FHA does have an exception for a non-occupying co-borrower. So the student or under employed child is allowed to have a parent or relative that can co-sign on the loan with the minimal down payment of 3.5%. Both incomes and debts will be computed into the debt ratio to determine affordability but this is a very common method of a parent helping a child obtain their first home. Both credit reports will reflect the mortgage so keep in mind that Johnny has to pay his mortgage or mom's credit rating will be affected too. If Johnny decides not to pay at all the lender will come looking for the co-borrower. The co-borrower owns the house just as much as the child does.
Scenario number one is the one that I receive the most calls on. Someone has poor credit but has a parent, friend, boyfriend etc. who is willing to co-sign. First and foremost, let me say this- it is not a sound financial decision for someone with good credit to co-sign for a loan for anyone with poor credit. Sound harsh? I am a big believer that past is prologue-which is not to say that someone may have a run of bad luck that affects their credit, and they will get the ship righted eventually. But only too often, the person with poor credit goes down with the ship taking the good credit co-signer with them. Fortunately or unfortunately, depending on your point of view, lending uses the lower of the two borrower's credit scores to determine loan eligibility. So a borrower with an exceptional credit score is of no help to a borrower with an ineligible credit score. Ineligible carries the day.
As I have often stated, the best thing that someone with low credit scores can do is, be patient, and work on the credit piece. Good credit is a habit. We are always happy to give someone with credit question guidance on how to improve their scores.
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