Sometimes you just need a little help. When thinking about buying a home, you want to make sure you can afford the new monthly payments. To do this, you need to speak with a mortgage loan officer. With just a brief conversation over the phone, you can get an update on current mortgage programs rates and closing costs. Yet as property values continue to move higher in many areas, what potential buyers want and what they can afford sometimes don’t align.
Mortgage lenders initiate an Ability to Repay, or ATR when qualifying borrowers. This is accomplished by comparing the new mortgage payment with gross monthly income. The mortgage payment, which also includes a monthly amount for property taxes, insurance, and potential mortgage insurance, should be around one-third of gross monthly income. This “debt ratio” is also applied when looking at total monthly debt including car payments, credit cards or student loans. But if the debt ratio is too high, sometimes a co-borrower can be the solution.
A co-borrower can be a relative such as a parent or a close friend. Most often, the co-borrower is a “non-occupying” co-borrower. The co-borrower will be listed on the mortgage but will not live in the property. When someone agrees to be a co-borrower, that individual is legally obligated to pay the loan should the primary borrower fail to do so.
A co-borrower needs to be clear that being on the mortgage means adding that debt to their own debt ratios. This is an important consideration because additional debt might hurt them when they apply for a new loan. If the new mortgage payment adds up to $2,000 per month, that additional $2,000 debt will appear on the co-borrowers’ credit report and immediately impact their own debt ratios.
When a lender evaluates a loan application where there is a co-borrower, the co-borrower is reviewed in the same manner as the primary borrower. A credit report will be pulled and reviewed for both the primary and co-borrower. What some buyers may not realize however is a co-borrower won’t be able to offset the primary borrower’s low credit scores. The primary borrower might have a credit score of say 670 but the co-borrower has a score of 780. The lender will always use the lowest qualifying score when multiple borrowers are on the same loan, whether or not an individual occupies the property or not.
Another issue potential co-borrowers need to consider is the payment history of the primary borrower. The most important factor when calculating credit scores is the payment history, which accounts for 35 percent of the total score. If a payment is made more than 30 days past the due date, the late payment will appear on both the primary borrower and the co-borrower’s credit report. Many times, the co-borrower isn’t aware of the late payment until it has already been registered.
When payments fall behind both the primary borrower and the non-occupying co-borrower will be contacted for payment. This could possibly mean the co-borrower’s credit score could be falling without their knowledge. Again, the higher credit score of the co-borrower has no impact on the overall loan approval. A co-borrower is there to assist with debt ratios.
Buyers should remember, not all mortgage programs permit a co-borrower. One benefit of FHA loans is the program does allow qualified co-borrowers that do not occupy the home. However, other programs like USDA loans may permit a co-signer, but they will be required to live in (occupy) the home. Other programs may not permit a co-borrower regardless if they live in the home.
A co-borrower should also be thought of as a temporary arrangement. If for example, a couple is having difficulty qualifying due to a lack of income, it should be expected that more income will be coming in the near future. Someone who has just graduated from college could fall into this category. A co-borrower can help qualify but at some point, the mortgage should be refinancing, releasing the co-borrower from any further repayment obligation. Getting a co-borrower to qualify as a long-term solution probably indicates the mortgage payment is too expensive for them and they should look to buy and finance a less expensive home.
If you’re thinking of asking someone to be a co-borrower, understand the financial risk that will be placed on the co-borrower. Your payment history will be listed on their credit report until at some point the mortgage is refinanced and the co-borrowers are removed from both the mortgage as well as the title report. But if you just need a little help for the short term to get you into the home you really want, a willing co-borrower might just be the answer.
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