We’ve all seen it happen to our close friends and relatives. They purchase a home, and you can feel their excitement; particularly first-time home buyers.

But too often, in a tight credit market, where lenders are particularly hard-pressed to approve loans, first-time homebuyers are declined for a variety of reasons. In many cases it’s due to poor credit and insufficient income. Both conventional loans and government backed loans such as FHA and VA loans allow for co-signers. A co-signer agrees to be responsible for the loan in the event the primary borrowers default on their loan payments.

Requirements of a Co-Signer

The requirements of a co-signer are different based on the type of loan being applied for. For example, conventional loans sometimes referred to a Fannie Mae loans, require that a co-signer live in the subject property along with the primary borrowers. In many cases, this is a problem because the co-signers have no intention of living in the new house. Some people assume lenders don’t follow up on this, but most lenders check the occupancy status of co-signers by sending a representative to the residence or sending mail to the co-signers at the new residence.

On FHA loans the co-signers don’t have to live in the residence and are considered non-occupant co-signers. This is the most lenient of all types of loans concerning co-signers, since VA loans also require that a cosigner occupy the residence as their main home.

Falsifying the occupancy status on a loan application is considered loan fraud and carries severe penalties both criminal and monetary.

Co-Signers Must Provide the Following:

• Two years income documentation including complete federal tax returns, W-2 forms, and current month paystubs
• Copy of current bank statements including checking and savings accounts and retirement accounts such as IRS’s or 401-K Statements
• A complete loan application (Form 1003) which shows all employment, income, assets and credit history

Advantages to Co-Signing

By co-signing a loan you are considered a legal owner of the property and as such can list it on your personal financial statement. This can have the effect of increasing your net worth on paper. Also as a  co-signor you may be able to take a tax write-off if certain conditions apply. In some cases your income might be substantially higher than the primary occupant and your tax benefit could be substantially greater than the primary borrower. This can usually be negotiated with the person you co-sign for with the idea that they take the write-off in later years. Simply helping a friend or loved one buy their first home might be the greatest advantage of all.

Disadvantages of Co-Signing

By co-signing, you are legally responsible for the loan. This means if the primary borrower defaults on the loan, the lender can hold you accountable to satisfy the obligation. Also, if the primary borrowers are consistently late on their mortgage payments, their credit scores will be adversely affected and so will yours. For example, if the primary borrowers show nine 30-day late payments on their credit reports, your credit report will also show the same late marks. In an age when almost all credit purchases such as car loans are based on credit scores, these negative marks can have a profoundly negative impact on your own credit. Also as a co-owner of the property, you are also potentially liable for any injuries or litigation that occur on the property. This is why it is extremely important as a co-signer to make sure the homeowner’s insurance or hazard policy is paid and up to date. One way to insure that this occurs is to insist that the house payments include an impound account for property taxes and insurance.

Cover Your Bases

If you do end up co-signing for a friend or relative, insist that you receive a copy of the monthly statements which show that the account is being paid. Do the same for the homeowners insurance policy as well. Also document that you are a co-signer and not the primary borrower. Even thought you are legally obligated on the debt, future creditors you work with will consider that your friend or family member actually makes the house payments and in this way, may not count the debt payments against you, if you try to purchase something on your own in the future.