If You Are a Cosigner on a Loan Here Is the Documentation Mistake That Could Hurt Your Mortgage

A Cosigner Situation That Comes Up More Often Than Most People Realize

If you have cosigned on a loan for a family member, if you are thinking about becoming a cosigner, or if you are planning to ask someone to cosign for you there is a documentation detail that has significant implications for your ability to qualify for a mortgage down the road. Getting it right from the beginning is simple. Getting it wrong creates a problem that is difficult to fix after the fact.

The Rule That Makes Cosigned Debt Manageable

When you cosign on a loan that debt appears on your credit report and in most cases it gets counted in your debt-to-income ratio when you apply for a mortgage. A car payment, a student loan, or any other obligation you cosigned on gets factored into your qualifying calculations even if you are not the one making the payments day to day.

There is an exception to this rule and it is genuinely useful for cosigners who are structured correctly. If you can provide twelve months of documented history showing that the primary borrower has been making the payment directly and consistently that debt can be excluded from your debt-to-income ratio calculation. Twelve months of the other party paying the debt on your credit report is the documentation threshold that allows the lender to remove it from the equation.

Where the Problem Comes In

As Matt Collett explains the issue surfaces regularly in conversations with clients who cosigned a loan with good intentions but set up the payment arrangement in a way that makes exclusion impossible when it comes time to apply for a mortgage.

The most common version of this mistake looks like this. A parent cosigns on their son or daughter's car loan. The child sends the parent cash each month and the parent makes the actual payment to the lender. From the parent's perspective the child is covering the payment. From a documentation standpoint the parent is the one making the payment and there is no twelve-month history of the child paying the debt directly.

When that parent later applies for a mortgage and wants to exclude the cosigned car payment from their debt-to-income ratio there is no documentation to support the exclusion. The payment has to be counted and depending on the amount that inclusion can affect how much the borrower qualifies for or whether they qualify at all.

How to Set It Up Correctly From the Beginning

The fix is straightforward but it has to be implemented from the start of the arrangement rather than retroactively when the mortgage application is already underway.

The primary borrower needs to make the payment directly to the lender from their own account every month. Not send cash to the cosigner. Not transfer funds to the cosigner who then makes the payment. The payment needs to come directly from the primary borrower to the creditor so that the payment history on the account reflects the primary borrower as the one servicing the debt.

With twelve months of that clean payment history documented the cosigner has the evidence needed to exclude the payment from their debt-to-income ratio when they apply for a mortgage. Without it the payment counts and the qualification picture changes accordingly.

If You Are Already in the Wrong Setup

If you are currently in a situation where the primary borrower is sending you cash and you are making the payment the most important thing you can do is correct the arrangement now and start building the documentation history you will need. The twelve-month clock starts from when the primary borrower begins making payments directly. The sooner the setup is corrected the sooner that clock starts running.

If you are planning to apply for a mortgage in the near term and the twelve-month history is not yet established that cosigned payment will need to be included in your debt-to-income ratio and your qualification should be evaluated with that inclusion in mind.

Matt Collett works with borrowers to evaluate exactly these kinds of situations and build a clear picture of how cosigned obligations affect mortgage qualification. Reach out to Matt Collett to find out where you stand and how to set up your documentation correctly before it becomes a problem.

Sources

ConsumerFinancialProtectionBureau.gov FannieMae.com Investopedia.com MortgageNewsDaily.corresponding BankRate.com