If someone is applying for a mortgage and cannot qualify for the mortgage they are seeking, their mortgage lender or mortgage broker would likely suggest they get a mortgage co-signer. They might ask you to help them by becoming their co-signer. You need to answer some questions before making an informed decision about co-signing their mortgage.
|Not qualified for a conventional or insured mortgage|
|Seek a cosigner||Work with an alternative lender|
|Investing social capital and using relationships||Using financial capital in the form of higher interest rates|
From a lender's viewpoint, there is little difference between cosigning for a mortgage loan or a joint mortgage. In both cases, there are two people from whom the lender would expect payment. From the lender's (mortgagee’s) viewpoint, it does not matter which party is making the payments. But these two scenarios are very different from the home buyer’s point of view.
In a joint mortgage scenario, both parties own the underlying property. They are expected to contribute to the down payment, mortgage installments and all other costs in proportion to their share of the underlying property. While in a cosigning scenario, one party has full ownership rights and is responsible for all payments, including down payment and mortgage installments. The other party is merely accepting responsibility for mortgage installments to help the home buyer qualify for the mortgage.
|A joint mortgage vs. a cosigned mortgage vs. having a guarantor|
|Has an ownership stake?||Yes||No||No|
|Their name appears on the title.||Yes||Yes||No|
|Is responsible for mortgage payments?||Yes||Yes||When lender can’t get it from borrower|
|Are they permanent?||Yes||No, a release of covenant is possible.||No, a release of covenant is possible.|
A friend might have done you favours in the past, or you might expect to ask them for favours in the future. In such situations, cosigning a mortgage might be the perfect way of doing a favour for a friend who is financially responsible. Alternatively, you might want to do a favour for a family member or friend whose success you care very much about. The only financial benefit from cosigning a mortgage is the boost to your credit profile from the on-time payment of a large loan.
Before extending a loan, a lender should gain a reasonable amount of confidence that the borrower is (or borrowers are) able to repay the loan. This is known as the underwriting process. For underwriting a mortgage, several factors are considered.
For example, the borrower should have demonstrated their responsibility for debt payments through their credit report and the resulting credit score. Their credit score plays a vital role each time they apply for credit. Whether they are applying for a credit card, a line of credit, a car loan or a mortgage loan, further, they should prove to have sufficient income to service all their debt already taken and the loan they are just applying for. Income sufficiency is evaluated using the total and gross debt service ratios.
If two people are signing for the loan instead of one person, the lender would consider the sum of their responsibility for debt payment by looking at their credit reports together. The lender would also consider the sum of their documented incomes and their debt and housing obligations to calculate debt service ratios. Thus a borrower can significantly increase the chances of their mortgage approval by enlisting a co-signer with a high credit score and low debt service ratio.
The downside of having a co-signer is qualifying for a loan more significant than one can afford and then struggling to pay installments. When housing markets are efficient or undervalued, this might not be a big risk since the house can be rented to pay the installments or sold to repay the mortgage. But after the 2008 financial crisis, we have witnessed years of financial repression in which interest rates are lowered by central banks via extensive money printing.
The Bank of Canada and other western central banks have artificially lowered interest rates for years. Low-interest rates inflate asset prices, including housing prices. In 2022, many Canadian housing markets, especially the Ontario housing markets and British Columbia housing markets, look inflated. Buying real estate which is both overpriced and unaffordable would do great harm to anyone's finances. It might take decades to fix the damage due to purchasing a simultaneously overpriced and unaffordable piece of real estate.
The main issue to consider when cosigning a mortgage or any loan is that this loan would be viewed as a liability for you. Until it is paid off, or until the borrower (home buyer) has improved their finances and you are removed from that loan, it reduces your chance of qualifying for other credit products. Thus you need to think twice about cosigning on a mortgage if you are planning to get a loan yourself. But the cost of cosigning a mortgage can be insignificant compared to the risk of cosigning a mortgage.
When considering cosigning a mortgage, you need to make a judgment call. You need to determine if the person can’t get the mortgage on their own because the bank is unaware of their responsibility, discipline and strong work ethic or if they can’t get the mortgage on their own simply because they can’t afford the mortgage.
If the issue is the limited information available to the bank, your risk would be little. But if the mortgage is simply unaffordable for them, you face a significant threat that they won’t be able to make their payments, and the lender would ask you to make the payments.
If they are close to qualifying, you might be able to help them find a lender with a lower mortgage rate, and the lower payments due to lower interest rates might enable them to qualify on their own. Alternatively, another lender might calculate debt service ratios slightly differently, allowing them to qualify independently.
When all attempts to get them to qualify on their own for an acceptable rate fail, you might be able to help them by becoming a guarantor instead of a consignor. By becoming a guarantor, you would be called to make a payment only when the lender fails to get the payment from the borrower. While as a consignor, you would be called upon to pay as soon as the borrower misses an installment.
Since your primary risk is having to pay their installments, it is best to make a contract with the main borrower obliging the mortgagor (homebuyer) to reimburse you in case you have to make any payment for them.