If you were nice enough to help a relative out by cosigning on a loan for them, it could affect your chances of getting a mortgage. It’s not the fact that you cosigned on a loan; that’s not the obstacle. It’s how it affects your debt ratio and possibly even your credit that matters.
When you cosign on a loan, you pledge to make the payments should the borrower default. The lender used your credit score and debt ratio to determine your likelihood of being able to do so. The hope is that it doesn’t get to that point. The borrower is supposed to make the payments. Should he stop, though, you are on the hook for the debt.
This could negatively affect your chance of getting a mortgage.
Your Debt Ratio
The largest issue is your debt ratio. When you apply for a home loan, lenders will pull your credit. The credit report will show the new lender your current debts. This includes the cosigned loan. Using the payments reported on the credit report, the lender will compare the total debts to your gross monthly income.
This doesn’t include the new mortgage payment yet. If your debt ratio is already high without the mortgage payment, it could be hard to get approved. Each loan program has different debt ratio requirements and they may vary by lender. Below are the most common ratios required:
- FHA – 31% front-end ratio and 43% back-end ratio
- VA – 43% back-end ratio
- USDA 29% front-end ratio and 41% back-end ratio
- Conventional – 28% front-end ratio and 36% back-end ratio
The back-end ratio is the one you have to worry about. The front-end is the new housing payment compared to your gross monthly income. Your total debts, which include the new mortgage and the co-signed loan, make up the back-end ratio.
Your Credit Score
Co-signing on a loan can negatively affect your credit score too. Hopefully, it doesn’t come to this and the borrower makes all of his payments on time. If, however, he defaults at any point, your credit gets hit too.
At a minimum, you have late payment marks on your credit report, such as a 30 or 60-day late payment. This can hurt your chances of loan approval, especially if it’s housing debt that you co-signed. If the borrower continues to default, you may see collection action or judgments on your credit report. These events drastically hurt your credit score and your chances of loan approval. Each loan program and lender has different credit score requirements including:
- FHA – 580 credit score
- VA – 620 credit score
- USDA – 640 credit score
- Conventional – 620 credit score
Individual lenders may require scores higher than the minimum to reduce the risk of default, though.
Proving you can Afford It Even With Cosigning
You have to prove to the lender that you can afford the home loan in addition to the debt you cosigned. This is where it gets tricky. If you cosigned on a mortgage, you’ll have two mortgage debts. You’ll need the mortgages to fit within the above debt ratios in order for a lender to consider your application.
If you don’t fall within those parameters, you may want to look for a portfolio lender. They keep the loans on their own books. In other words, they make the rules. They may allow higher debt ratios and/or lower credit scores. Even if they don’t, they may have other exceptions that your typical programs don’t have.
What to do if you are Denied
What happens if all lenders deny you because of the loan you cosigned? You have one option – ask the borrower to refinance. If you cosigned because the borrower had a high debt ratio at the time of application, hopefully he’s had time to bring it down.
The borrower will have to refinance the loan and qualify on his own in order to remove you from it. This isn’t easy, but if enough time has passed and the borrower is on better financial ground, it may be a possibility.
Cosigning on a loan is serious business as it puts your money, credit, and future loans at risk. Before you cosign on a loan, make sure you and the borrower are on the same page. Ask that it be a temporary solution while the borrower cleans up his credit and pays down his debts. Have a timeline set that the borrower will refinance so that you can be freed from the loan and move on with your own financial life.