Loan underwriters are hard to please. When a mortgage loan approval eludes the hopeful homebuyer, another signature on the papers might be the only way to move forward.
Why Will a Lender to Refuse to Approve a Mortgage Loan?
The reasons can be several:
- The hopeful buyer does not have enough credit history.
- The applicant has not had any (or enough) W-2 income for the past two years. Lenders balk at 1099 and independent contractor income, so it’s harder for gig-economy workers or self-employed entrepreneurs to qualify.
- The hopeful buyer’s debt-to-income (DTI) ratio—monthly financial commitments divided by gross income—is too high. The U.S. Consumer Financial Protection Bureau suggests that borrowers with a higher than 43% debt-to-income ratio can run into trouble making their monthly mortgage payments.
Should one or more of these factors frustrate the loan applicant, the financial backing of an additional person may demonstrate to an underwriter that the loan can be repaid.
Before finding or being an angel, it’s important to know what role the helper will play. The extra person might simply be co-signing—but in all likelihood they’ll actually co-own the home.
The Co-Signer for a Mortgage Loan Is Not On the Deed.
A second person can co-sign the mortgage loan without being on the title and deed. This may happen with an FHA loan, which is more likely than a conventional loan to accept the assurances of a non-occupant co-signer. If the title names only the primary borrower, the co-signer is technically a guarantor rather than a co-borrower.
What is the distinction? A guarantor does not actually have a legal interest in the asset. For example, a guarantor may not pledge the property as loan collateral.
A mortgage, by definition, pledges the home as collateral for the loan. This is why mortgage lenders prefer—and often require—that every borrower’s name goes on the title.
So, if you are expecting the assistance of a co-signer to get a loan approval for a home, prepare to accept a shared ownership arrangement—at least until you can arrange a successful refinancing.
Pro tip: Some mortgage loans, FHA loans included, are assumable with the same terms and interest rate that were originally extended. This may enable a buyer to get approved for a loan with a co-owner, then assume the loan independently later under the same terms.
The Co-Borrower Is Named on the Deed.
A co-borrower on a mortgage loan is also a co-owner. Both borrower and co-borrower are named on the real estate title, deed, and mortgage—even though the co-borrower never expects to pay a penny.
And although the co-borrower never expects to pay, unexpected emergencies can arise. If the primary buyer, who lives in the home, cannot make a monthly mortgage payment, the lender holds a non-occupant co-owner just as responsible for the payment.
This means the co-owner is actually responsible for the month-by-month payment of the loan—unlike a guarantor, who will only be called on to pay the outstanding debt after a primary borrower’s default. Should this worst-case scenario—default—occur, a guarantor, who is not on the deed, has no claim to the value of the home purchased through the mortgage loan. Guarantors pledge their own assets as collateral.
In the best-case scenario, the primary buyer enjoys the home and makes monthly mortgage loan payments faithfully. After a while—especially if the home appreciates in value—the primary buyer can significantly lower the loan-to-value ratio on the home. Then, when the primary buyer successfully applies for refinancing as a sole buyer, the co-owner will go to the deed recorder’s office in the county where the property is located, and take their name off the deed. More on this below.
While co-ownership can be a great option for buyers who are also life partners, this arrangement is rarely what a single person has in mind when deciding to buy property. Yet a non-occupant co-owner can provide an essential stepping stone on a buyer’s way to individual home ownership.
Pro tip: If you agree to serve as a co-buyer to enable a primary buyer to purchase a home, consider creating a separate, legally binding agreement under which the primary buyer secures refinancing approval two years after the initial purchase. Hold the primary borrower responsible for allowing you to come off the mortgage, the deed and title, and the homeowner’s insurance policy by the agreed-upon time frame.
All’s Well That Ends Well—When the Co-Borrower Comes Off the Deed.
When the primary borrower succeeds in refinancing the home independently, the co-borrower can sign the deed over to the new sole homeowner. A quitclaim deed can relinquish the co-borrower’s interest.
Pro tip: If you are a non-relative, and you agree to serve as a co-buyer to enable a primary buyer to purchase a home, speak with the title company about limiting your percentage of ownership interest. This will allow the primary buyer to pay a lower real estate transfer tax, when the time comes for you to convey your portion of the interest to the primary buyer. Transfer taxes typically apply to real estate conveyances between people who are not related. Transfer taxes are state taxes. Most but not all states impose these taxes.
Now, only one owner is named on the title and deed. Congratulations all around! And the name of the good Samaritan co-borrower will forever be etched into the home’s chain of title.