Many young couples dream of picket fences and homeownership. When the time comes to get a mortgage loan, you may get a shock that your credit history isn't good enough. Many underwriters recommend asking someone such as a parent to co-sign your mortgage loan for you. . Co-signers use their incomes and credit histories to guarantee payment on a loan. A co-signer has all the responsibilities but none of the benefits as the loan applicant.
A co-signer's main responsibility is to guarantee that payments are made on the account. As the primary borrower, if you miss a payment your lender may contact your co-signer to secure payment. The co-signer makes the payment on your behalf to keep her credit history intact.
Every mortgage loan varies, but generally speaking, a co-signer does not have property rights to the house. He cannot take possession of the property or sell it to recoup his money. It depends on whether the co-signer is listed as a co-borrower with property rights or as a simple co-signer. Check your mortgage documents for the exact status.
The lender may choose to go after the co-signer to pay the loan if you default. If the house goes into foreclosure, the lender may sell the house at auction and assign a bill for the difference between the sale price and the balance. The bill is sent to you and the co-signer and you both may be sued in civil court for the balance. If you file for bankruptcy protection, that protection does not extend to your co-signer, who is still liable for the balance due on the mortgage.
Everything that appears on your credit report in regards to this account also appears on your co-signers report. The account balance, payment history, any collection accounts, judgments or foreclosures all appear on the co-signers account. Negative entries lower your and your co-signer's credit score. Positive account history increases your co-signer's credit score.
Removing a Co-Signer
Removing a co-signer eliminates her liability and responsibility on the mortgage loan. However, it isn't as easy as making a phone call. The mortgage loan must be satisfied either through payment in full or through a refinance. Refinancing your mortgage loan when your credit score and income increases removes your co-signer from the loan and takes the risk from her hands. Removing your co-signer does not automatically happen. You must refinance your mortgage loan specifically excluding the co-signer from the refinance application.
About the Author
Leigh Thompson began writing in 2007 and specializes in creating content for websites. She has been published online in various capacities. Thompson has an associate degree in information technology from the University of Kansas and is working on a bachelor's degree in business and personal finance.
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This “ 11 Things to Consider Before Co-Signing a Loan ” post provides overview about what people (i.e. people who intend to co-sign) need to be aware of before putting their signatures on the loan applications.
Co-signing a loan for someone can be a generous thing to do but can be dangerous at the same time. I’ve heard so many horrible stories about people helping out others through co-signing with horrible results. It is true that doing this can be daunting especially when you hear these kinds of stories.
There are many situations that co-signing a loan for somebody is necessary especially when that person is just starting to build up credit. If you are a parent, you may find the need to do it for your child. Of course, family may be exceptions to the unwritten rule of “Don’t co-sign for others”.
What is co-signing?
Co-signing is simply signing a legal document jointly with another person. According to the Federal Trade Commission (FTC), when you co-sign a loan, the lender must spell out what your obligations are as a co-signer. FTC also states that when you co-sign a loan, you are asked to guarantee the debt. In addition, you may have to pay the full amount if the borrower does not pay.
Why is there a need to co-sign?
One of the main reasons that co-signers is needed is that the main borrower is unable to obtain a loan under his own name. This can happen when the borrower doesn’t have good credit or simply has not built up credit yet.
Things to Consider Before Co-Signing a Loan
A lot of people would say to never co-sign for anybody. The risks associated with doing this can or will far outweigh the benefits and this statement is true. But before you say yes or no to co-signing, it is best to understand and get a better picture of what the risks and repercussions are when co-signing goes wrong.
One of the things to consider Before co-signing a loan is to know that purpose of the loan is.
Before even entertaining the idea of helping somebody through co-signing a loan, always ask where the loan is going to be used. It is a basic question that many co-signers fail to ask.
If the borrower is going to use the money to pay for another debt, you may need to re-consider if you really need to co-sign a loan with that borrower. Ask yourself how the person’s going to pay the loan. Is he or she going to ask for another loan to pay the current loan?
However, if the person is in need of immediate loan because of some emergency situations like medical issues, then, you may consider co-signing for that person if you know he or she is responsible in handling and managing finances especially loans.
There’s always a purpose for getting a loan. It is within your right to know it especially if you’re the one co-signing the loan application.
When you co-sign for somebody, you are considered the borrower in the eyes of the credit bureaus. This means that the loan will reflect on your credit history as well as that of the main borrower. If the borrower fails to pay on time and/or defaults, then, you will see that your credit score will take a hit.
You need to take this fact into consideration when somebody is asking for your help. Once you co-sign for somebody, you will need to make sure that payment is made on time. If you’re too busy to mind other people, then, it’s in your best interest to decline such request.
You don’t want to baby sit the main borrower but you may have to especially when your credit is on the line.
You may have helped one of your family members or friends get a loan by co-signing. This is a good way to build and enhance relationship. Having said this, you still need to take precautionary measures to maintain a good relationship with the person you care, in this case, the borrower.
A lot of people fail to pay their loans and they go into default. Just because the person who you helped is close to you, doesn’t mean that situations like this won’t happen to him or her. If ever the borrower fails to pay the loan and defaults, then, your relationship may be at stake. I hope it doesn’t happen to you but there’s always a possibility that your relationship will get sour if he or she does end up in this situation.
You will need to sit down and talk about the repercussions of not being able to fulfill the terms of the loans. As much as you want to believe that your relationship will not be affected when something wrong happens, the truth is that relationship can be negatively affected when loans don’t get paid. It’s just a reality of life and a lot of relationships have been broken because situations like this happen.
You may ask who will be responsible when the main borrower fails to pay the loan. The answer is simply you. As co-signer, you are responsible to pay the loan back along with the late fees and accrued interest. In many cases or states, you have equal footing on the loan and so, you are as responsible as the main borrower when it comes to paying back the loan.
According to the FTC, studies have shown that 3 of 4 or 75% of those co-signed loans that end up on default end up having to be paid by the co-signer.
You may find that this is not the worst situation. If the borrower has been in default for a couple of months, you will find your unpaid loan in the hands of the collection agencies. When this situation happens, you are looking at paying additional fees on top of late fees and accrued interest.
This scenario is not the scenario that you want to be in but this is one of the realities that can or will happen to you if the borrower fails to pay the loan and, then, defaults.
I’m not trying to discourage or frighten you. The idea of co-signing is guaranteeing the creditor that you will pay the loan back in case the main borrower fails to pay.
Of course, if you are co-signing a loan for someone who can’t get a loan and the loan is approved, the person will surely be happy. But happiness can be short lived. The person may not care about paying the loan and can go into default.
When co-signing with other people, always make sure to check the credit background of the people you will likely help. You’ll never know how well or bad their credit scores are until you check them.
You will also need to understand their spending habits. You may also need to sit down with the borrower and ask how he or she is serious with paying back the loan. Of course, he or she may say yes but it’s always best to be straightforward. After all, your credit score is only one of the many things at stake in co-signing.
Of course, you don’t just pull up their credit histories without informing them. Let them know that it’s your requirement before you consider helping them. If they refused to do so, then, it may be best for you to distance yourself from helping them. Sometimes, precaution is better that solution.
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If you, as the co-signer, secures a loan with your own property such as your house, you are running the risk of losing your property. This may happen if the borrowers fails to pay the loan back.
When co-signing a secured loan, always make sure that you understand the risk of losing your property. Better yet, you may not even want to co-sign a secured loan as this may hit you hard twice (one with your credit score and the other with losing your property).
7. Tax Consequences
If the main borrower fails to pay the loan and goes into default, you may find yourself looking for ways to solve the problem before it gets worse. You or the lender may find that settlement is better. This settlement is almost always below the outstanding balance. You think your dilemma is over? Hardly.
You could face tax liability for the difference between the outstanding balance and the settled amount. For example, if you still owe $15,000 and the lender settled for $8,000, then, you may have to report the $7,000 in your tax return as debt forgiveness income. Remember this amount may be considered income and you will need to report it and pay taxes on it.
The lender may provide you a 1099-C also known as Cancellation of Debt.
8. Future Loans
Ever wonder why a lot of people can’t seem to get another house loan, car loan, among others? This may be because they already have the same type of loans in their credit file.
If you co-signed somebody for a car loan, you may find that you may not be able to get another credit of the same type. If you do get a loan, you may find that you will have to pay more interest just because your credit utilization ratio is higher.
If you are looking at getting a loan for yourself in foreseeable future, you may be better off if you stay away from co-signing another person. Always take time and think things through before co-signing for somebody.
A misstep can make a big difference on your ability to secure a loan of your own in the future.
Yes, even the wages or assets you own can be garnished if ever you and/or the main borrower default(s) from the loan.
According to Tuition.io, for private student loans, there must be a court judgment before your wages or assets can be garnished. On the other hand, for the federal loans, lenders can go ahead with garnishment if you defaulted.
You are not only affecting your credit score but you are also affecting your wages or the assets you own.
While co-signing a loan may seem to have more risks than benefits, there are benefits of co-signing a loan. Co-signing is one of the ways you can do to can help another person build his or her credit. If you happen to co-sign a loan with your child, then, you are helping your child build his or her credit.
Young people especially those who want to start building their credit may not necessarily be able to start doing it because they don’t have credit in the first place. Sounds crazy, right? Not really. This is the irony when it comes to building up a credit. You need to have a credit to build a credit. One of the best ways to do it is through co-signing a loan with that person.
This doesn’t mean that you need to take out a huge amount of loan so you can help your son or daughter build up his or her credit. You can always take a $500 loan and start from there.
Since you are the parent, it is best to orient your child about responsible borrowing. This is one of your ways to teach your child on how to manage and handle responsibilities.
11. Exit Strategy
When you co-sign for somebody, it is best to have an exit strategy prior to signing on the signature line(s) on the loan application. Always make sure that you understand what you and the main borrower will get into and plot an exit strategy to remove yourself from loan equation. Not a lot of lenders may allow you to get out of the loan. If that’s the case, you will be stuck until the loan has been paid off.
It doesn’t hurt to ask the lender if it allows the co-signer to be removed from the loan at a certain point.
The decision of co-signing an application should not be taken lightly. The decision you make can and will affect you positively or negatively. It’s always a great idea to make necessary steps to ensure that you safeguard not only your credit scores but also those important things in your life such assets and relationships that can be negatively affected.
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