When filling out a loan application, you want to appear as credible and trustworthy as possible to lenders. The U.S. Department of Housing and Urban Development (HUD)’s General Guidelines for Analyzing Borrower Credit cites credit history as “the most useful guide to determining a borrower’s attitude toward credit obligations, and predicting a borrower’s future actions.”
In other words, lenders look to your payment patterns to determine their risk in issuing a loan. If you appear risky to them, they might charge a higher interest rate as collateral in the case you default on your loan, or they may choose to not lend to you at all. Luckily, a co-borrower or co-signer can send a positive signal to a lender, and both parties can benefit.
What Is A Co-Borrower?
A co-borrower, or co-applicant, agrees to accept equal responsibility for repaying a loan and equal ownership in the investment. In real estate investments, co-borrowers are typically family members or spouses who will share ownership of a property, sign all loan documents and be named on the deed. When a co-borrower doesn’t plan to live on the property, but rather wants to help the primary applicant qualify for a better loan, they are often called co-applicants.
Co-borrowers are mainly used when the primary applicant has good enough credit to qualify for a loan, but not good enough to earn a better interest rate. Because lenders are required to base loan rates off of the lowest median credit score between both applicants, it wouldn’t make sense to add a co-applicant with a bad credit score. It does, however, make sense to add a co-borrower with a low debt-to-income (DTI) ratio, which can lower the loan application’s DTI average and help the borrowers qualify for a larger principal and lower interest rate.
What Are The Benefits And Considerations For Co-Applicants?
Whether you’re the primary applicant, considering asking a trusted friend or family member to become a co-borrower or you’re considering signing on as a co-borrower, there are benefits and considerations for everyone involved.
Every loan has different requirements. For example:
- VA loans require a DTI of no more than 60%, but all borrowers must be qualified veterans, service members or their spouses.
- FHA loans offer lower credit requirements, but you’ll be required to pay mortgage insurance premium.
- Conventional loans are more difficult to qualify for, but a large down payment will let you avoid paying those private mortgage insurance fees.
Comparing which loan types you qualify for is crucial to understand if and when you’ll need a co-borrower. Here are a few of the benefits of co-borrowing:
- Both applicants will build good credit as payments are made.
- Both applicants will enjoy ownership of the property.
- Adding a co-borrower with lower DTI could help you qualify for a higher principal and lower interest rates.
Here are a few of the considerations:
- Co-borrowers are financially responsible for investing up front and for making regular payments.
- If the primary borrower defaults on a payment, the co-borrower is financially responsible.
- If a co-borrower dies and the remaining borrower isn’t listed as a successor to the deed, they may face housing insecurity.
What Is A Co-Signer?
Both co-borrowers and co-signers are assuming fiscal responsibility, although in different ways. A co-signer can leverage their good credit by promising to assume financial responsibility only if the applicant defaults. Unlike co-borrowers, co-signers are not making any regular payments toward ownership and their name isn’t on the deed. Their role is to reassure lenders that the loan will be repaid, primarily if the borrower is very young with little to no credit history.
Student loans, first-time apartment leases and car leases are the most common examples of when a parent or other family member might co-sign a loan application to help their child obtain assets and build their credit. In real estate, divorcees, self-employed home buyers and young professionals often benefit from having a co-signer.
What Are The Benefits And Considerations For A Co-Signer?
Of course, being able to help a family member receive a lower interest rate may seem attractive to a co-signer, especially if the applicant is a trustworthy young person, and both parties could benefit from co-signing.
Here are a few of the benefits:
- As the borrower makes payments, both parties might strengthen their credit scores.
- The co-signer doesn’t have to make regular payments.
- The borrower enjoys sole ownership of the property.
Here are a few of the considerations:
- If the borrower defaults, the co-signer assumes all financial obligations without any rights to the deed.
- If the borrower defaults on the loan, the co-signer’s credit score and cash reserves may suffer.
When Does A Co-Borrower Make Sense?
Co-signing is the best option if the primary borrower is ready to take full financial responsibility on a property or rental agreement. The co-signer doesn’t have to put any money up front and is only liable if the borrower defaults. The borrower can enjoy full ownership of the property or investment and start building a healthy financial future.
Co-borrowing makes more sense if the primary applicant is prepared to make a riskier, larger investment in a property. Applying together will likely increase the chances of qualifying for a larger mortgage and lower interest rates. Co-borrowing is also a better option over co-signing if the primary applicant has questionable financial habits. If they default on the loan, the co-borrower will at least have ownership in the property, whereas a co-signer will be investing solely to protect their credit score.
Of course, there are workarounds to allow for two individuals to own a property, but not apply for a loan together. This is a good option if one occupant has filed for bankruptcy or has poor credit. The borrower would simply add both names on the property deed and leave the other spouse's name off the loan application.
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