Picture this: Your landlord has decided to sell your home, and when you mention this to your parents, they offer to cosign a home loan so that you can finally buy a place of your own.
Is this the best idea they’ve ever had, or is it going to wreck every future holiday dinner spent together?
Potential homebuyers with high student loans, a history of self-employment, or a recent divorce who are ready to plunk down the cash to purchase their first home may find that a weak credit score is torpedoing their mortgage application. According to the National Association of Realtors (NAR) 2021 Homebuyers and Sellers Generational Trends, 24% of potential homebuyers had their mortgage applications rejected because of their low credit score in 2020.
In this article, you’ll learn how a credit score impacts your home loan as a primary borrower, how a cosigner can improve your home loan application, what lenders look for in a cosigner, and how to remove a cosigner from your mortgage.
What Is a Credit Score?
A credit score is a measurement of how well you pay back the money you borrow, and it’s calculated by the three major credit bureaus: Equifax, Experian, and TransUnion. Your credit score breaks down into five categories:
- 35% Payment History- Late payments cost you more than money. Every time you fail to pay on time, your payment history takes a hit and lowers your overall credit score.
- 30% Total Amount Owed- Usually referred to as the debt-to-income ratio (DTI), this number calculates all of your debt, including store credit cards, store furniture loans, student loans, and car loans and compares it to your income.
- 15% Age of Credit- Did you put off opening a credit card until you were in your late 20s? The age of your credit indicates how old your credit lines are. It rewards consumers that not only open credit accounts but also keep them open.
- 10% Type of Credit- Revolving credit like credit cards is weighted differently than installment credit like student loans. Lenders prefer seeing a mix of credit that shows that you can handle different payment schedules and types of debt.
- 10% New Credit- A borrower who’s recently opened up three new lines of credit may appear to be going on a shopping spree. Newly opened credit accounts in quick succession send up a red flag to the credit bureaus who prefer to reward steady and reliable borrowers.
Debt-to-Income Ratio (DTI)
In addition to your credit score, a bank will also consider your debt-to-income ratio or the percentage of your income that will go towards paying your debts.
The 28/36 Rule
Most lenders prefer a DTI that follows the 28/36 rule. This means that no more than 28% of your monthly income should be spent on a mortgage, and the rest of your monthly debt payments shouldn’t exceed 36% of your income.
Math Example:
Your Annual Income: $65,000
Your Monthly Income: $5,416
Amount Available for Mortgage: $1,516
Amount Available for Other Debts: $1,949
Does a Cosigner Improve My Mortgage Application?
A strong cosigner can buoy up your credit score but it doesn’t guarantee that your mortgage application will be approved. After all, a credit score is only a small part of the application process. Depending on the type of loan, cosigners may have to meet different requirements.
- VA loans require that the cosigner is also a qualified borrower; additionally, if the cosigner is not a spouse and is a non-veteran, VA loans require a 12.5% down payment.
- FHA loans require that the cosigner lives in the U.S. unless the cosigner is serving in the military or is a U.S. citizen living overseas.
- Some financial institutions may require that the cosigner lives in the same state, but this will vary.
Adding a cosigner with an excellent credit score and larger income can strengthen your home loan, but a cosigner carrying a heavy debt load runs the risk of reducing the size of the loan you can take out. You’ll both shoulder the liability of taking on the loan. When choosing a cosigner, think carefully about their financial circumstances before asking them to cosign your home loan.
What Do Lenders Require From a Cosigner?
The Federal Housing Administration (FHA) publishes official guidelines for cosigners, but individual banks can require more or less information based on their lending criteria. A cosigner is responsible for your home loan without the benefit of actually owning your home, and they have to provide the same kind of documentation to the bank to prove they can carry your home loan if you stop paying for any reason.
This is the information a lender will want a cosigner to provide:
- Recent pay stubs
- Tax returns
- Bank statements
- Credit report
- Job verification
You’ll need to communicate regularly with your cosigner as you work through the application process so that you don’t miss a deadline.
Removing a Cosigner from Your Loan
Maybe your cosigner is going through some personal problems, or maybe they’re just ready to pass their responsibility back to you. If they ask for removal on your mortgage loan, you’re probably wondering, What do I do now?
A cosigner is not on the title of your home, but they are on the mortgage. Removing a cosigner from your home loan is a legal process that establishes that you can handle a mortgage as a borrower or co-borrower. You will need to refinance your home to remove your cosigner from the loan, and you’ll need to be ready to qualify for a mortgage on your own.
Refinance
The refinance process looks almost exactly like the mortgage process. You’ll bring to the table the same financial documents that you showed to the lender when you purchased your home. You’ll have your home appraised again, and you’ll sign papers with the title company.
Quitclaim Deed
As you go through the refinance process, you’ll also need to draw up a quitclaim deed to file with the county. You’ll need to include the address of the property, a description of the property, and the property’s parcel number. After having this legal document notarized, your cosigner can go on their merry way.
You’ll want to maintain a good relationship with your cosigner so that they don’t surprise you with a refinance. By keeping the lines of communication open, you’ll be able to refinance and remove them from your mortgage when you’re ready to qualify for a mortgage independently.
The Bottom Line
Using a cosigner can be a powerful strategy to improve your mortgage application. If your credit score doesn’t reflect how reliable you are, then asking a family member or close friend to cosign your mortgage may be a great opportunity for you to purchase your own home.
Don’t forget that cosigning also carries risks for the cosigner. Stretching your finances thin to purchase a home and then realizing that you can’t handle the responsibility of a mortgage can strain your relationship with your cosigner. If you choose to use a cosigner to purchase your home, pay your mortgage on time and you’ll never have to worry about awkward holiday dinners.
