Can Co-Signing Help? What Are the Hazards?
February 23, 2009
Co-signing arises when one party agrees to be liable for the debt of another party. It is used less often on home mortgages than on other types of loans.
The economic distress of 2008-9 has battered the credit scores of many potential borrowers, while causing lenders to increase the scores they are willing to accept. The result is a growing number of co-signing requests.
A co-signer with good credit cannot overcome the bad credit of a mortgage borrower. Lenders use the credit of the borrower whose income is used to qualify. They will not use the credit of a co-signer.
While a co-signer cannot improve the credit score used to price the loan, the co-signer’s income may be added to the borrower’s income in determining the size of loan for which the borrower qualifies. On FHA loans, 100% of the co-signer’s income can be used to raise the qualifying loan amount, up to the FHA loan limit. However, the co-signer’s debt is added to the borrower’s debt in determining the qualifying loan amount. This means that if the co-signer’s debt is large , his inclusion could add little or nothing to the qualifying loan amount.
On conventional (non-FHA and non-VA) loans, the picture is very different. Most conventional loan programs don’t allow non-occupant co-signers at all. Those that do typically limit the incremental income to 50% of the co-signer's income, but they include 100% of the co-signer’s debt. As a result, there aren’t many co-signers on conventional loans.
Some co-signers have had their lives severely disrupted when the borrower for whom they co-signed stopped paying, leaving it up to the co-signer to make the loan good. Most of the mail I get on the subject is from co-signers in this situation. They now regret they did it, and they invariably ask me how they can get out of it. I discuss this question below.
On the other hand, probably the great majority of cases of co-signing have a happy ending. Stories with happy endings seldom get into my mail box, but I had one in my own family that illustrates the potential benefits of co-signing. When my younger son left the military, he had no credit but needed an automobile, so I co-signed his note. Within 18 months, he had paid off the loan and his credit was well established. I never had to co-sign for him again.
I co-signed his note because he was my son, but that was only part of the reason. The other part was that I had information about him that the lender did not have. Specifically, I knew he was a straight arrow who always met his commitments.
Co-signing fails when the borrower defaults and the co-signer has to make good on his pledge. Why does this happen? Sometimes a responsible borrower draws a bad card from the deck of life, such as illness or job loss. A co-signer can’t avoid that risk. The risk they can and should avoid is co-signing for someone who is not responsible.
I recently read through some of the letters I have received where co-signing ended in default by the borrower, and severe distress for the co-signer. What struck me was that in most of these cases the co-signers had no better information about the capacity and willingness of the borrower to repay than the lender. Indeed, in many cases, the co-signer had persuasive evidence that the borrower was not reliable, which evidence they chose to ignore.
Why? Usually the reason was strong feelings of obligation to help a relative, friend or lover. The guilt they would have felt in refusing, along with the fear that refusal would destroy the relationship, overwhelmed their better judgment. When it is someone near and dear, it is hard to say no.
But if you are not fully confident that, absent unusual circumstances, the borrower will meet her obligation, "no" is what you need to say. It can destroy the relationship, that’s the borrower’s call, but the relationship will also be destroyed if she defaults. And if that happens, your financial security could be destroyed with it.
The letters below are typical of many I receive from people who co-sign without giving it much thought, or who are asked to co-sign with false assurances.
"I co-signed a loan for my brother-in-law who has since left my sister and has stopped paying the note…The lender is now after me to pay. How can I get out of this?"
You can't. Once you co-sign a note, there are only two ways to get out of it. Either the loan must be repaid in full, by the borrower or you, or the lender must agree to take you off.
The lender is not going to let you off the hook because the borrower stopped paying. The risk of non-payment is why the lender required a co-signer in the first place! The lender doesn't care that the borrower left your sister, he just wants to be repaid.
"My nephew has asked me to co-sign his mortgage. He says that after the loan is closed, I will be taken off the deed and my obligation will terminate. Is this right?"
No, removal of your name from the deed does not eliminate your obligation.
"My brother in law has asked me to co-sign for a home and the real estate agent tells me that after six month of good payment by the borrower I can be removed from the title and loan. Is this true?"
Probably not. It is strictly up to the lender, who might let you off the hook in 6 months, or perhaps after 12 months, or perhaps never.
"In a week moment I agreed to help a friend get a mortgage by co-signing his note. My friend has always made the payments, but I discovered that his mortgage shows up as debt on my credit report, and it prevents me from getting a mortgage of my own. How do I deal with this?"
This is a loan qualification problem, not a credit problem. Lenders impose limits on the amount of existing debt a borrower can carry, and a co-signing obligation is considered debt for qualification purposes.
This problem can usually be remedied by documenting that the borrower has been making the payments on time for a reasonable period. The lender in such case will probably remove the debt from your loan application. You remain a co-signer, but the lender is ignoring your obligation to the other lender in assessing your ability to repay a new loan.
"I have been asked to co-sign a rental agreement so a friend can get an apartment. Is this the same as co-signing for a loan?"
They are very similar. If you co-sign for a loan, you are on the hook until the loan is paid in full, unless the lender lets you off. If you co-sign for a lease, you are on the hook for the period of the lease, unless the landlord lets you off.
Effect of Debt Consolidation on a Co-Signing Obligation
"If a student has a co-signer for college loans and consolidates those loans when he is employed, are the co-signers removed from the loans? If not, are the co-signers notified of their position (responsibility) with the new lender/lenders?"
"Consolidation" usually means that existing loans are repaid and replaced with a new loan. Where that happens, any co-signers are off the hook.
Sometimes, however, "consolidation" means that a third party has made a deal with a borrower to receive payments from the borrower, with the third party passing on the monies to the various lenders. In this case, the original loan contracts remain in force and the co-signers remain liable. It is unlikely that the co-signers will be notified in either case.
"Our daughter has asked us to co-sign for her to buy a home. She will be 39 in May, married with 3 children, she can afford to put 3% down. We are retired, our income is approximately $56,000 per year, and we have a mortgage balance of $117,000. Our daughter has said that in the event the unexpected happens and she can't meet the payments, she would sell the home and give us a portion of proceeds."
In general, my view is that seniors with limited income and a mortgage of their own have no business co-signing for someone else’s mortgage. I am sure that your daughter’s promise to sell the house in an emergency is made in good faith, but it will not protect you unless she has enough equity in the house to assure that the sale proceeds will be sufficient to pay off the mortgage. A down payment of 3% will not do it, especially in a declining real estate market.
Co-signing arises when one party agrees to be liable for the debt of another party. It is used less often on home mortgages than on other types of loans.
The economic distress of 2008-9 has battered the credit scores of many potential borrowers, while causing lenders to increase the scores they are willing to accept. The result is a growing number of co-signing requests.
Co-Signing Provides Limited Help on a Mortgage
A co-signer with good credit cannot overcome the bad credit of a mortgage borrower. Lenders use the credit of the borrower whose income is used to qualify. They will not use the credit of a co-signer.
While a co-signer cannot improve the credit score used to price the loan, the co-signer’s income may be added to the borrower’s income in determining the size of loan for which the borrower qualifies. On FHA loans, 100% of the co-signer’s income can be used to raise the qualifying loan amount, up to the FHA loan limit. However, the co-signer’s debt is added to the borrower’s debt in determining the qualifying loan amount. This means that if the co-signer’s debt is large , his inclusion could add little or nothing to the qualifying loan amount.
On conventional (non-FHA and non-VA) loans, the picture is very different. Most conventional loan programs don’t allow non-occupant co-signers at all. Those that do typically limit the incremental income to 50% of the co-signer's income, but they include 100% of the co-signer’s debt. As a result, there aren’t many co-signers on conventional loans.
Co-Signing Means Assuming a Major Risk
Some co-signers have had their lives severely disrupted when the borrower for whom they co-signed stopped paying, leaving it up to the co-signer to make the loan good. Most of the mail I get on the subject is from co-signers in this situation. They now regret they did it, and they invariably ask me how they can get out of it. I discuss this question below.
Most Co-Signings Have a Happy Ending
On the other hand, probably the great majority of cases of co-signing have a happy ending. Stories with happy endings seldom get into my mail box, but I had one in my own family that illustrates the potential benefits of co-signing. When my younger son left the military, he had no credit but needed an automobile, so I co-signed his note. Within 18 months, he had paid off the loan and his credit was well established. I never had to co-sign for him again.
I co-signed his note because he was my son, but that was only part of the reason. The other part was that I had information about him that the lender did not have. Specifically, I knew he was a straight arrow who always met his commitments.
Co-signing fails when the borrower defaults and the co-signer has to make good on his pledge. Why does this happen? Sometimes a responsible borrower draws a bad card from the deck of life, such as illness or job loss. A co-signer can’t avoid that risk. The risk they can and should avoid is co-signing for someone who is not responsible.
The Big Mistake: Co-Signing For Someone Who Is Not Responsible
I recently read through some of the letters I have received where co-signing ended in default by the borrower, and severe distress for the co-signer. What struck me was that in most of these cases the co-signers had no better information about the capacity and willingness of the borrower to repay than the lender. Indeed, in many cases, the co-signer had persuasive evidence that the borrower was not reliable, which evidence they chose to ignore.
Why? Usually the reason was strong feelings of obligation to help a relative, friend or lover. The guilt they would have felt in refusing, along with the fear that refusal would destroy the relationship, overwhelmed their better judgment. When it is someone near and dear, it is hard to say no.
But if you are not fully confident that, absent unusual circumstances, the borrower will meet her obligation, "no" is what you need to say. It can destroy the relationship, that’s the borrower’s call, but the relationship will also be destroyed if she defaults. And if that happens, your financial security could be destroyed with it.
How Can You Get Out of a Co-Signing Obligation?
The letters below are typical of many I receive from people who co-sign without giving it much thought, or who are asked to co-sign with false assurances.
"I co-signed a loan for my brother-in-law who has since left my sister and has stopped paying the note…The lender is now after me to pay. How can I get out of this?"
You can't. Once you co-sign a note, there are only two ways to get out of it. Either the loan must be repaid in full, by the borrower or you, or the lender must agree to take you off.
The lender is not going to let you off the hook because the borrower stopped paying. The risk of non-payment is why the lender required a co-signer in the first place! The lender doesn't care that the borrower left your sister, he just wants to be repaid.
"My nephew has asked me to co-sign his mortgage. He says that after the loan is closed, I will be taken off the deed and my obligation will terminate. Is this right?"
No, removal of your name from the deed does not eliminate your obligation.
"My brother in law has asked me to co-sign for a home and the real estate agent tells me that after six month of good payment by the borrower I can be removed from the title and loan. Is this true?"
Probably not. It is strictly up to the lender, who might let you off the hook in 6 months, or perhaps after 12 months, or perhaps never.
Co-Signing Can Affect Your Qualifications For a Loan
"In a week moment I agreed to help a friend get a mortgage by co-signing his note. My friend has always made the payments, but I discovered that his mortgage shows up as debt on my credit report, and it prevents me from getting a mortgage of my own. How do I deal with this?"
This is a loan qualification problem, not a credit problem. Lenders impose limits on the amount of existing debt a borrower can carry, and a co-signing obligation is considered debt for qualification purposes.
This problem can usually be remedied by documenting that the borrower has been making the payments on time for a reasonable period. The lender in such case will probably remove the debt from your loan application. You remain a co-signer, but the lender is ignoring your obligation to the other lender in assessing your ability to repay a new loan.
Co-Signing a Lease
"I have been asked to co-sign a rental agreement so a friend can get an apartment. Is this the same as co-signing for a loan?"
They are very similar. If you co-sign for a loan, you are on the hook until the loan is paid in full, unless the lender lets you off. If you co-sign for a lease, you are on the hook for the period of the lease, unless the landlord lets you off.
Effect of Debt Consolidation on a Co-Signing Obligation
"If a student has a co-signer for college loans and consolidates those loans when he is employed, are the co-signers removed from the loans? If not, are the co-signers notified of their position (responsibility) with the new lender/lenders?"
"Consolidation" usually means that existing loans are repaid and replaced with a new loan. Where that happens, any co-signers are off the hook.
Sometimes, however, "consolidation" means that a third party has made a deal with a borrower to receive payments from the borrower, with the third party passing on the monies to the various lenders. In this case, the original loan contracts remain in force and the co-signers remain liable. It is unlikely that the co-signers will be notified in either case.
Will a Commitment to Sell Protect the Co-Signer?
"Our daughter has asked us to co-sign for her to buy a home. She will be 39 in May, married with 3 children, she can afford to put 3% down. We are retired, our income is approximately $56,000 per year, and we have a mortgage balance of $117,000. Our daughter has said that in the event the unexpected happens and she can't meet the payments, she would sell the home and give us a portion of proceeds."
In general, my view is that seniors with limited income and a mortgage of their own have no business co-signing for someone else’s mortgage. I am sure that your daughter’s promise to sell the house in an emergency is made in good faith, but it will not protect you unless she has enough equity in the house to assure that the sale proceeds will be sufficient to pay off the mortgage. A down payment of 3% will not do it, especially in a declining real estate market.