Purchasing a home is often a family business. With help from a spouse or relative, people can overcome financial barriers and become homeowners. The process of sharing the financial stress of a mortgage loan with a significant other is called co-borrowing.
Adding A Co-Borrower To Your Mortgage
What Is A Co-Borrower?
In general, the term co-borrower is used to talk about a person who is on someone else’s mortgage. However, financial institutions are more specific when using the term. For lenders, a co-borrower is a person whose income, assets and credit history are considered in the mortgage loan application. Most financial institutions only use the term when applicants are a married couple or partners.
Co-borrowers are equally responsible for mortgage payments and must have ownership of the property. If one co-borrower cannot cover their monthly share of mortgage payments, the other must do so to avoid a default. Sometimes, one co-borrower is not living in the property. In such cases, lenders call them a non-occupant co-borrower.
Relatives or friends can also be added to a mortgage application. In this case, lenders refer to them as co-applicants. The difference is that due to not being married or in a partnership, most financial institutions will analyze each co-applicant’s finances separately. As such, lenders will issue separate loan applications for the same mortgage to each co-applicant. Like co-borrowers, co-applicants also appear on the property’s title and are responsible for mortgage payments.
Borrowers can also add to their mortgage application people who will not appear on the property’s title. They can be friends, relatives or parents helping their children complete their first home purchase. Lenders use the term co-signer when referring to them.
Co-signers are responsible for mortgage payments, and their finances are often considered for the loan application. Co-signing is used by families to help kick start the financial history of their children. A similar strategy is to become a guarantor, who is only responsible for the loan when borrowers cannot cover monthly payments.
Having a co-borrower is not required to get approved for a mortgage. However, people often rely on their relatives to improve their financial position and qualify for bigger loans. Although adding a co-borrower can be beneficial, there are some cases in which it might not make sense to do so.
When to add a co-borrower to your mortgage
The main benefit of adding a co-borrower to a mortgage is it can bring additional income and assets for a loan application. In general, lenders approve larger loan amounts to applicants with co-borrowers, as it reduces risk of default. Sometimes, adding a co-borrower helps applicants avoid financial barriers they could otherwise face on their own.
An important metric lenders consider before approving a mortgage loan is debt-to-income ratio or DTI. This number represents how much income goes into monthly debt payments, including credit card bills, car loans, and existing mortgages. For example, someone who makes $40,000 annually, paying $1,200 a month to debt accounts, will have a 36 percent debt-to-income ratio. Having a debt-to-income ratio above 50 percent is among the top reasons why mortgage lenders deny an application.
Borrowers with debt-to-income ratio above 50 percent can avoid being rejected by adding a co-borrower to their mortgage application. However, this strategy only works if the combined debt-to-income ratio of all co-borrowers falls below 50 percent. Using the example above, someone with 36 percent DTI would be a good candidate to help a relative, earning $30,000 each year and paying $1,300 a month to debt accounts, get approved for a mortgage loan. Their individual debt-to-income ratio is 36 and 52 percent. However, when combined, their DTI averages 42 percent.
There are situations in which it makes no financial sense to put someone, spouse or relative, on a mortgage application. If it’s only a matter of ownership, borrowers can always add their spouses or partners to the property’s title without making them co-borrowers. It may be because they already have enough accumulated debt or prefer not becoming responsible for monthly payments. The same principle can be followed by parents who want to share ownership with their children.
Debt-to-income ratio is not the only thing affected by adding a co-borrower to a mortgage. Financial institutions also take a look at other financial data before choosing whether to approve or reject an application. As a result, borrowers should make some extra considerations before going forward with a co-borrower.
What should be taken into consideration when bringing a co-borrower to the table
There are several things applicants should consider before adding a co-borrower to their mortgage. First, lenders will determine qualification according to the credit scores of each co-borrower. To qualify for a mortgage, all co-borrowers must have a credit score within lender requirements. In general, lenders require a credit score of at least 600 points for traditional mortgages. FHA mortgages, which are government-backed loans with flexible requirements, are available to people with scores as low as 500.
Credit scores will also determine the interest rates attached to a mortgage loan application. Lenders often use the lower credit score to calculate interest rates and payment schedules. Unless additional income is required to qualify for a mortgage loan, borrowers should only add co-borrowers whose credit score is at or above theirs. Otherwise, it might be better not adding them to a mortgage application.
Adding a co-borrower is also useful when the primary borrower has little or no credit history. Children who are purchasing a home for the first time often use this approach to take advantage of their parents’ extensive credit history.
Adding someone to your mortgage application is a decision with significant consequences. Co-borrowing means accepting several risks, including default and loss of credit score. However, being a co-borrower is not permanent. Homeowners can always refinance their properties, replacing or removing those who no longer want to be on the mortgage.