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How does co-signing a mortgage work?

by Corben Grant on 23 Aug 2022

Co-signing a mortgage is a very useful option for homebuyers looking to help make their home purchase succeed even with a less than ideal financial profile. However, co-signing is also a choice that should not be taken lightly, and should be carefully considered by all parties involved.

Before you choose to use a mortgage co-signer, or before you agree to be one, it is important that both parties understand the process and what it means to them. If done right, a mortgage co-sign can be a great way to help you get a mortgage when you wouldn't otherwise be able to. If not handled correctly, it can prove disastrous for both parties.

In this article, we will explore how a mortgage co-sign works, and what you need to know when deciding to use this mortgage option.

What is co-signing?

When you apply for a mortgage, your lender needs to determine how reliable you will be as a borrower. This decision will be made on a number of points such as your income, your credit score, your existing debt, your down payment, the home you want to buy, and more.

Unfortunately, with so many different factors that come into play, it is very easy for one or more to end up not measuring up to what the lender expects. This can be a frustrating thing to happen, especially when you know that you are capable of handling a mortgage payment. Unfortunately, banks can't simply take every borrower's word and must base their decisions on risk reduction principles.

They do offer an option however to make up for your shortcomings, and this is co-signing. When you co-sign, you are essentially adding another person to your mortgage who the bank can use to qualify the mortgage loan. 

Ideally, this person has a better financial status than you or at least makes up in areas where you fell short. The idea behind co-signing is that the second borrower not only implicitly vouches for your reliability but they also legally agree to cover the mortgage payments if you fail to do so.

Usually, this means that the primary lender will cover the loan payments and the co-signer will only step in when the primary lender fails to pay, however, in the eyes of the lender both are equally responsible to make sure every payment is made.

Co-signer vs Guarantor

There is another similar option to co-signing, and this is using a mortgage guarantor. These two options are fairly similar but unique in their own ways.

For the most part, a co-signer and guarantor function the same. A third party helps the primary lender to get a mortgage by vouching for the lender and guaranteeing their payments in the event of default. Just like a co-signer, a guarantor will need to have a strong financial condition of their own for the bank to accept them.

The primary difference is that a guarantor does not sign the mortgage contract, nor do they take any title on the home. As a result of the lower obligation put on a guarantor, lenders tend to be less willing to offer mortgages under this arrangement. Using a guarantor may be most viable for a mortgage borrower who is close to being approved but just needs a small boost.

Co-sign vs Co-borrower

Co-signing may also sound very similar to the process of having a co-borrower, as many people choose to do when buying a home with a spouse or partner. In most regards, a co-borrower and a co-signer function much the same, however, the primary difference is the relationship between the two borrowers. 

On top of usually being in a close relationship like marriage, they are also agreeing to split the debt and the payments, rather than one person agreeing to take over if the other defaults. Many people will use a co-borrower even if their financial situation is perfectly healthy, simply so both partners can have ownership of their home.

What is the process like?

When you choose to use a co-signer for your mortgage, you will need to do so at the approval stage. This may occur the first time you try for approval, or you may choose to retry for approval after a failed attempt without a co-signer.

Your co-signer will be required to provide essentially the same information that you would have as the primary borrower. This may include identification, proof of employment, pay stubs, bank statements, a credit report, tax forms and more. This information as well as your own will be included with the mortgage application.

When should I get a co-signer?

As mentioned before, you should consider getting a co-signer when you are at risk of failing to be approved for a mortgage. This may be your first mortgage, or it may be at the time of renewal.

One of the most common times for a buyer to use a co-signer is if they have a damaged credit score but otherwise strong financials. A co-signer can allow them to access better mortgage terms at a major lender without having to resort to alternative lenders.

You may also want to consider a co-signer if you have a short employment history or a recent layoff. This will help your lender to overlook these issues and help you purchase your home earlier.

When you are considering getting a co-signer, you need to remember that it is a very big favour to ask of someone, and there is often little incentive for them to do so other than their own kindness. There may also be a significant downside for someone who chooses to co-sign a mortgage. All this is to say that if you are able to get a co-signer, you should be very thankful for their help, and not feel too upset if they are forced to turn you down.

In addition, you need to be prepared to pay back this kindness in return by being a good co-signer yourself. If you choose to stake someone else's financial health on your own ability to pay your mortgage, you should do everything in your power to uphold that promise and not see it as a free out.

Who can co-sign?

Anyone can be a co-signer, but that doesn't mean anyone should. One of the most common co-signers that people will use is their parents, or in the case of retired parents with adult children, the child may serve as the co-signer.

The reason parents are a popular co-signer is, for one, the fact that parents want to help their children succeed. But from a financial perspective, a home buyer's parents may have a much longer employment history, higher savings, and perhaps some value accrued in home equity. All of these things will make them appealing to a lender. 

This is especially helpful for young professionals who recently graduated from school, and may have some money and a good job. but not enough to have a work or credit history to get a mortgage. It may also be used alongside a gifted down payment to help make home buying much easier for the next generation.

In general, the better your co-signer's financial health the better your chances of being approved. This means a high credit score, high income, low debt, and more. Approaching the bank with a sub-par co-signer is simply asking for further rejection.

Should I be a co-signer?

On the other side of things, you may at some point be faced with the decision to be a co-signer for someone else. Though you may feel pressure to accept for personal reasons, such as if they are a friend or family member, you need to carefully consider the decision before you do anything. Ultimately, this is not a personal decision but a financial one.

First of all, you should talk to your potential co-signer about why they are unable to get a mortgage in the first place. This can help you to understand how reliable they will be as a borrower. 

If for example you know they have a reliable job and savings but in the past have damaged their credit score, you may feel confident in helping them out. On the other hand, if you know they are not good with money and are unable to get a mortgage due to consistent money mismanagement, you may want to reconsider their request.

You also need to consider what co-signing will mean for you. For example, if you co-sign a mortgage, that debt will now be included in your own debt ratios, which may make it more difficult for you to get further loans or credit later on. In addition, you will need to provide a lot of your personal financial information to the lender, which may present a privacy issue for you.

Being a co-signer can also affect your credit score, as your rating will be tied to the mortgage. If your co-signer misses a payment, that will reflect on you as well. You may also find yourself on the hook for capital gains tax if the home is sold depending on if you have an interest in the home.

When you co-sign a mortgage, you will be locked into the mortgage contract along with the other borrower, however, there is a way to remove yourself as a co-signer. It is possible to get a co-signer release, but this will need to be approved by both the lender and other borrower, so it will not necessarily be within your power to willingly remove yourself.

Overall the decision will never be black and white, and it can be tough to turn down a friend or family member. Consider speaking with a mortgage broker or financial advisor who can help you to decide if your co-sign is a good idea or not.

It is also worth looking at ways to protect yourself as a co-signer if you do sign. This may include taking only a small stake in the property to avoid tax implications, as well as getting life insurance for you and your co-signer to protect you in the event of an unexpected death. You should also request copies of all paperwork and documentation, and carefully read them to understand your rights and responsibilities. For the most protection, consider speaking to a real estate lawyer.

Alternative to getting a co-signer

If you are considering getting a co-signer but aren't certain yet, or if you failed in finding a co-signer that was willing to help, there may still be some other options that can help you to get your home, though they may require you to change your plans somewhat.

Try a different mortgage

Oftentimes a borrower may not be approved for a certain mortgage or a certain home but may qualify for something different. For example, you may want to choose to get a less expensive home that will help you to increase your down payment. You might also want to consider getting a different mortgage that offers a lower rate in order to help you pass the stress test. If you are set on a specific home, this may not be ideal, but it may be a better option than no home at all.

Shop around to different lenders

If one lender has rejected you, that doesn't mean they all will. Looking for other lenders can help by getting you a lower rate, as well as by finding lenders who have lower qualifying criteria.

If you have been rejected from a major lender, you may have trouble getting qualified by another. In general, these lenders have the highest qualifying criteria and will have similar requirements as each other. Luckily, there are many options beyond this.

Alternative lenders, credit unions, and private lenders may all be viable options in getting your mortgage approved. Many of these lenders specialize in working specifically with lenders who may not be approved for mortgage loans by the major lenders and are an increasingly popular option for Canadian home buyers. 

Note however that getting a mortgage with lower qualifying conditions will require you to make some concessions. In many cases, these mortgages can have higher interest rates or additional fees that will make them more expensive. Again, when faced with the opinion between less favourable mortgage terms and not getting a mortgage at all, it is clear why home buyers nonetheless choose this option.

Wait and improve your financial status

This may be the least desirable option for those who are hoping to get a home soon, but it may also be one of the wisest. If you have been rejected by lenders, it may be worth stepping away from the home-owning dream, at least temporarily, until you are more suited to being a borrower.

For example, taking time to save and improve your down payment can help you to get approved much more easily. You may also need to take some time to improve a damaged credit score, which while possible will take some time to see results.

Though you may think you are able to maintain a mortgage now, consider why the lenders may reject you. They know very well what it takes to afford a mortgage, and the exceptionally high standards are in place to protect borrowers as much as to protect the lenders. It will prove even more damaging to your financial health if you rush into a mortgage you can't afford and are forced to default. On the other hand, waiting to get your mortgage will put you in an even better place to maintain your mortgage, and can set you up for further success.



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