It happens to many of us. A friend or relative calls and asks to talk. Then, a few minutes into an awkward conversation, you're asked to cosign a mortgage loan. If you find yourself in this situation, you might want to think twice before agreeing. You need to consider both the upsides and downsides carefully.
Of course, the upside of cosigning a loan is that you can help a loved one get a loan they otherwise couldn't get on their own, enabling them to purchase a home or save interest with a lower rate. And, if the primary account holder manages the account responsibly, you might see a slight improvement in your own credit.
While it's tempting to rush to help a friend or family member, you should first understand your obligations and know what might happen if the person you're helping fails to repay the loan. The big downside to cosigning someone else's loan is that you agree to pay the mortgage if the primary borrower doesn't. It's risky for your credit, and potentially your relationship with the borrower, to guarantee a loan.
The advice for those considering cosigning a loan for a family member or friend is usually not to do it. And if you do, be sure you understand the consequences if something goes wrong.
So, before you commit to helping your son, daughter, or other loved one by becoming a cosigner on a mortgage loan, consider all of the pitfalls, and learn about:
Being a cosigner on a home loan—or any loan—is a status that carries no rights at all. While you'll share liability for the cosigned mortgage with the borrower, you most likely won't get an ownership interest in the property. So, you risk having to repay the loan without benefitting from living in the home or owning a part of it.
As far as responsibilities, you're 100% responsible for the complete repayment of the loan. Before you cosign, you need to ensure you're comfortable covering the mortgage payments if the primary borrower can't.
If the primary borrower makes the loan payments on time, that information might or might not show up on your credit report. It depends on the creditor. Not all of them report to cosigners' credit reports when payments are made on time.
Cosigning a loan could help your credit if the creditor reports that the primary account holder is managing the account responsibly and making on-time payments. And the new account adds to your credit mix. (Having different types of credit, like mortgages and credit cards, can help your credit scores.) But even if the creditor reports the payments to the major reporting bureaus, you'll likely only get a slight benefit to your credit scores. Because you were a worthy cosigner, you probably don't need more positive notations on your credit report to boost your scores.
In fact, you'll probably see a temporary reduction in your credit scores when the lender pulls your credit before approving the mortgage loan you're cosigning. This hard inquiry will ding your credit, and so will the increase in your overall debt load. Credit bureaus factor in loans that you cosign for as a debt obligation when figuring your credit scores. Cosigning a mortgage loan can raise your total debt balance and reduce your credit scores accordingly.
Also, knowing about your liability on a cosigned debt, other lenders might refuse to make additional loans to you because you might appear overextended. So, before you agree to cosign a mortgage loan, consider whether you plan to buy a house, car, or another item on credit within the period that the borrower is paying off the mortgage, which could be decades.
If the primary borrower pays late or, even worse, defaults on the loan, your credit will take a hit. The borrower might not be too concerned about negative credit reporting because they already had bad credit (obviously, otherwise, a cosigner wouldn't have been necessary).
As a cosigner, not only will your credit scores fall, but you'll also be liable for repayment of the debt, including late fees and collection costs. The lender can come after you as though you were the primary borrower. The lender might contact you and tell you that the loan is delinquent. If you don't bring the loan current or work something out, like a repayment plan, the lender might take further collection steps against you and the primary borrower, including conducting a foreclosure.
And depending on state law, the lender might sue you for a deficiency judgment if the foreclosure sale doesn't bring in enough money to repay the loan. Eventually, the lender might be able to garnish your wages or levy your bank account to pay off the debt.
You'll need to make the necessary payments to get the loan out of default to protect your credit. Then, you'd want to deal with the main borrower to fix the problem. Here are a few things to think about:
If you end up paying the lender voluntarily or because you got sued after the primary borrower failed to pay, you might need to file a suit against your family member or friend to get your money back. Suing a family member or a friend can destroy what was formerly a good relationship. Saying "no" to cosigning in the first place can be hard, but it might save you a lot of stress down the road.
Also, while getting a judgment against your family member or friend probably won't be difficult, getting them to pay up might be. After winning a lawsuit, you still have to collect the money awarded in the judgment—the court won't help you with this. You might need to hire a debt collection attorney or law firm to assist you.
If you decide to cosign someone's mortgage loan, make sure you fully trust the primary borrower. You'll want to keep the lines of communication open between you and the borrower so you can discuss financial difficulties before they become a problem. Ask the primary borrower for access to the loan account and regularly keep track of the payments, ensuring they're paid on time. You can also ask the lender to notify you immediately if the primary borrower misses a payment.
It's also a good idea to prepare a written agreement between you and the borrower upfront so that you both understand expectations and what will happen if the primary borrower doesn't pay. This contract should include details about:
It's also a good idea to keep an amount equal to a monthly payment or two in your savings account just in case you need to cover a payment.
You could consider alternatives to cosigning, like:
Also, keep in mind that a local housing assistance program or affordable homebuyer program might be available to help the home buyer, keeping you out of the picture.
The risks of cosigning a mortgage loan aren't worth it for many people. If, however, you're still thinking of guaranteeing repayment of someone else's home mortgage loan after evaluating all the downsides, consider talking to a real state attorney or debt relief attorney.
An attorney can put the terms of the arrangement between you and the primary borrower into a written agreement before you cosign the loan, advise you further about the potential consequences, and answer any questions you have.