Co-signing: Smart or Stupid?

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Realtor.com quoted me in Co-signing a Mortgage: Smart or Stupid? It opens,

There’s no doubt about it: Buying a home these days is hard. Even if you’re lucky enough to be a homeowner yourself, that doesn’t mean your kids or assorted loved ones can easily follow in your footsteps—at least, not without help.

One way that “help” can occur for home buyers who don’t qualify for a mortgage? Getting someone else—like you, dear reader—to co-sign. In a nutshell, that means that if they can’t pay their monthly dues, the lender will expect you to cough up the cash instead.

 It’s a noble idea, helping someone buy a home. But also, of course, a scary one. It’s no surprise that many co-signers are parents doing what parents do: putting their own financial well-being aside to help their children move into a home.

But let’s be clear here: The risks are huge. Some of them are obvious, but there are plenty more that you may not have even considered. So if you’re considering co-signing, it’s best you know exactly what you’re getting into, and how to protect your finances in case things don’t go well. Here are the main caveats and considerations to keep in mind.

Identify if your borrowers (and you) are good candidates

We’re not saying co-signing is a terrible idea across the board. There are plenty of legit reasons why those near and dear to you may have trouble getting the loan on their own—say, because they’re self-employed, which makes banks leery. But if your kid can’t get a loan because he just can’t seem to pay his AmEx card on time, well, that’s a different story. Judge your own risk accordingly.

Co-signers should also consider whether they’re good candidates to be taking on more financial commitments. Generally, you should consider co-signing only if you meet a few requirements. For example, “You own your home free and clear and don’t require much credit or have a need for it,” says Mary Anne Daly, senior mortgage adviser with San Francisco–based Sindeo.

Consider the pitfalls

If your borrower has a less-than-stellar history of paying back creditors or holding down a job, proceed with caution. Extreme caution.

“Unfortunately, I’ve seen parents dig further into their savings to pay the mortgage when their child can’t make the payment,” says Ryan Halset, a Realtor® with Seattle-based Boardwalk Real Estate. And if you can’t pay, it will tarnish your credit history and future odds of borrowing money.

“Your chance of getting a loan yourself in the future could be in jeopardy,” says Janine Acquafredda, an associate broker with Brooklyn-based House N Key Realty. “Not to mention the risk of ruining relationships if things go sour.” But maybe that last part’s a given.

Think like a lender

Hard as it might be, try to keep your personal relationship with the home buyer from coloring your decision. Even if it’s your child or a longtime pal, it shouldn’t (entirely) trump the warning signs.

“Before you commit, think like a lender and look at the borrower’s income, work history, and existing debt to determine if the borrower is worthy and not a potential liability to your good credit,” says Frank Tarala, owner of Sterling Heights, MI–based Principal Brokers Network.

Saying no may be tough, but it could save you tons of heartache down the road. David Reiss, professor of law and academic program director for the Center for Urban Business Entrepreneurship, recounts a situation where parents stepped in as co-signers just before the financial crisis hit. The home’s value plunged by more than half. The borrower then left the area—and his home—in search of a new gig and couldn’t make both the mortgage payments and the rent on his new apartment.

“The parents, retirees living on a modest pension in their own home, found themselves dealing with the default of their son’s mortgage with no financial resources available as a buffer,” Reiss says. “This situation has devolved into a nightmare of defaults and attempted short sales with no end in sight.”

Final Accounting for National Mortgage Settlement

Attributed to Jacopo de' Barbari

Luca Pacioli, A Founding Father of Accounting

Joseph Smith, the Monitor of the National Mortgage Settlement, has issued his Final Compliance Update. He writes,

I have filed a set of five compliance reports with the United States District Court for the District of Columbia as Monitor of the National Mortgage Settlement (NMS or Settlement). The following report summarizes these reports, which detail my review of each servicer’s performance on the Settlement’s servicing reforms. This report includes:

• An overview of the process through which my team and I have reviewed the servicers’ work.

• Summaries of each servicer’s performance for the third quarter 2015.

Pursuant to the Settlement, the requirement to comply with the servicing standards ended for Bank of America, Chase, Citi, Ditech and Wells Fargo as of the end of the third quarter 2015. Accordingly, this is my last report under the NMS for these servicers. Like all mortgage servicers, they are still required to follow servicing-related rules issued by the Consumer Financial Protection Bureau (CFPB). (2)

Smith concludes,

The Settlement has improved the way these servicers treat distressed borrowers, and, under its consumer relief requirements, the banks provided more than 640,000 borrowers with $51 billion in debt forgiveness, loan modifications, short sale assistance and refinancing at a time when families and the market were subject to distress and uncertainty.

I believe the Settlement has contributed towards the rebuilding of public trust and confidence in the mortgage market and hope that it will inform future regulation of financial institutions and markets. I look forward to further discussions on these topics among policymakers, consumer advocates and mortgage servicers. (13)

I have blogged about the Monitor’s earlier reports and have been somewhat unhappy with them. Of course, his primary audience is the District Court to which he is submitting these reports. But I do not believe that the the reports have “contributed towards the rebuilding of public trust and confidence in the mortgage market” all that much. The final accounting should be accurate, but it should also be understandable to more than a select few.

The reports have been opaque and have not give the public (even the pretty well-informed members of the public, like me) much information with which to contextualize their findings. I hope that future settlements like this take into account the need to explain the findings of decision makers and court-appointed monitors so that the public can have a better sense of whether justice was truly done.

Systemic Servicing Failure

Joseph A. Smith, Jr.

Joseph A. Smith, Jr.

Joseph A. Smith, Jr., the Monitor of the National Mortgage Settlement, issued An Update on Ocwen’s Compliance. It opens,

I filed a compliance report with the United States District Court for the District of Columbia (the Court) today that provides the results of my tests on Ocwen’s compliance with the National Mortgage Settlement (Settlement or NMS) servicing standards during the third and fourth calendar quarters of 2014. (2)

The Monitor found that Ocwen (which has been subject to numerous complaints) failed at least four metrics and a total of ten metrics are subject to some type of corrective action plan. As with many of these reports, the prose is turgid, but the subject is of great concern to borrowers who have mortgages serviced by Ocwen.  Problems were found with

  1. the timeliness, accuracy and completeness of pre-foreclosure initiation notification letters
  2. the propriety of default-related fees
  3. compliance with short sale notification requirements regarding missing documents
  4. providing the reason and factual basis for various denials

The Monitor concludes, “The work involved to date has been extensive, but Ocwen still has more work to do. I will continue to report to the Court and to the public on Ocwen’s progress in an ongoing and transparent manner.” (5) This sounds like bureaucratic understatement to me.  Each of these failures has a major impact on the homeowners who are subject to it.

The Kafka-esque stories of homeowners dealing with servicers gone wild are graphic and frightening when a home is on the line. And when I read the corrective actions that the Monitor is implementing, it reads more like my 6th grader’s report card than like a plan for a massive corporation. One of them is “ensuring accuracy of dates used in letters.” (Appendix ii) Hard to imagine a grown up CEO needing to be told that.

I have wondered before how a company under court-ordered supervision could continue to behave like this. I remain perplexed — and even a bit disgusted.

Expanding the Credit Box

Tracy Rosen

DBRS has posted U.S. Residential Mortgage Servicing Mid-Year Review and 2015 Outlook. There is a lot of interest in it, including a table that demonstrates how “the underwriting box for prime mortgages slowly keeps getting wider.” (7) The report notes that

While most lenders continue to originate only QM [Qualified Mortgage] loans some have expanded their criteria to include Non-QM loans. The firms that are originating Non-QM loans typically ensure that they are designated as Ability-to-Repay (ATR) compliant and adhere to the standards set forth in the Consumer Financial Protection Bureau’s (CFPB) Reg Z, Section 1026.43(c). Additionally, most Non-QM lenders are targeting borrowers with high FICO scores (typically 700 and above), low loan to values (generally below 80%) and a substantial amount of liquid reserves (usually two to three years). Furthermore, most require that the borrower have no late mortgage payments in the last 24 months and no prior bankruptcy, foreclosure, deed-in-lieu or short sale. DBRS believes that for the remainder of 2015 the industry will continue to see only a few Non-QM loan originators with very conservative programs.

CFPB ATR And QM Rules

The ATR and QM rules (collectively, the Rules) issued by the CFPB require lenders to demonstrate they have made a reasonable and good faith determination, based on verified and documented information, that a borrower has a reasonable ability to repay his or her loan according to its terms. The Rules also give loans that follow the criteria a safe harbor from legal action. (8)

DBRS believes

that the issuance of the ATR and QM rules removed much of the ambiguity that caused many originators to sit on the sidelines for the last few years by setting underwriting standards that ensure lenders only make loans to borrowers who have the ability to repay them. In 2015, most of the loans that were originated were QM Safe Harbor. DBRS recognizes that the ATR and QM rules are still relatively new, having only been in effect for a little over a year, and believes that over time, QM Rebuttable Presumption and Non-QM loan originations will likely increase as court precedents are set and greater certainty around liabilities and damages is established. In the meantime, DBRS expects that most lenders who are still recovering from the massive fines they had to pay for making subprime loans will not be originating anything but QM loans in 2015 unless it is in an effort to accommodate a customer with significant liquid assets. As a result, DBRS expects the availability of credit to continue to be constrained in 2015 for borrowers with blemished credit and a limited amount of cash reserves. (8)

The DBRS analysis is reasonable, but I am not so sure that lenders are withholding credit because they “are still recovering from the massive fines they had to pay for making subprime loans . . ..” There may be a sense of caution that arises from new CFPB enforcement. But if there is money to be made, past missteps are unlikely to keep lenders from trying to make it.

Going It Alone on Your Mortgage

walking alone

WiseBread quoted me in When It Makes Sense to Apply for a Mortgage Loan Without Your Spouse. It opens,

You and your spouse or partner are ready to apply for a mortgage loan. It makes sense to apply for the loan jointly, right? That way, your lender can use your combined incomes when determining how much mortgage money it can lend you.

Surprisingly, this isn’t always the right approach.

If the three-digit credit score of your spouse or partner is too low, it might make sense to apply for a mortgage loan on your own — as long as your income alone is high enough to let you qualify.

That’s because it doesn’t matter how high your credit score is if your spouse’s is low. Your lender will look at your spouse’s score, and not yours, when deciding if you and your partner qualify for a home loan.

“If one spouse has a low credit score, and that credit score is so low that the couple will either have to pay a higher interest rate or might not qualify for every loan product out there, then it might be time to consider dropping that spouse from the loan application,” says Eric Rotner, vice president of mortgage banking at the Scottsdale, Arizona office of Commerce Home Mortgage. “If a score is below a certain point, it can really limit your options.”

How Credit Scores Work

Lenders rely heavily on credit scores today, using them to determine the interest rates they charge borrowers and whether they’ll even approve their clients for a mortgage loan. Lenders consider a FICO score of 740 or higher to be a strong one, and will usually reserve their lowest interest rates for borrowers with such scores.

Borrowers whose scores are too low — say under 640 on the FICO scale — will struggle to qualify for mortgage loans without having to pay higher interest rates. They might not be able to qualify for any loan at all, depending on how low their score is.

Which Score Counts?

When couples apply for a mortgage loan together, lenders don’t consider all scores. Instead, they focus on the borrower who has the lowest credit score.

Every borrower has three FICO credit scores — one each compiled by the three national credit bureaus, TransUnion, Experian, and Equifax. Each of these scores can be slightly different. When couples apply for a mortgage loan, lenders will only consider the lowest middle credit score between the applicants.

Say you have credit scores of 740, 780, and 760 from the three credit bureaus. Your spouse has scores of 640, 620, and 610. Your lender will use that 620 score only when determining how likely you are to make your loan payments on time. Many lenders will consider a score of 620 to be too risky, and won’t approve your loan application. Others will approve you, but only at a high interest rate.

In such a case, it might make sense to drop a spouse from the loan application.

But there are other factors to consider.

“If you are the sole breadwinner, and your spouse’s credit score is low, it usually makes sense to apply in your name only for the mortgage loan,” said Mike Kinane, senior vice president of consumer lending at the Hamilton, New Jersey office of TD Bank. “But your income will need to be enough to support the mortgage you are looking for.”

That’s the tricky part: If you drop a spouse from a loan application, you won’t be penalized for that spouse’s weak credit score. But you also can’t use that spouse’s income. You might need to apply for a smaller mortgage loan, which usually means buying a smaller home, too.

Other Times to Drop a Spouse

There are other times when it makes sense for one spouse to sit out the loan application process.

If one spouse has too much debt and not enough income, it can be smart to leave that spouse out of the loan process. Lenders typically want your total monthly debts — including your estimated new monthly mortgage payment — to equal no more than 43% of your gross monthly income. If your spouse’s debt is high enough to throw this ratio out of whack, applying alone might be the wise choice.

Spouses or partners with past foreclosures, bankruptcies, or short sales on their credit reports might stay away from the loan application, too. Those negative judgments could make it more difficult to qualify for a loan.

Again, it comes down to simple math: Does the benefit of skipping your partner’s low credit score, high debt levels, and negative judgments outweigh the negative of not being able to use that spouse’s income?

“The $64,000 question is whether the spouse with the bad credit score is the breadwinner for the couple,” says David Reiss, professor of law with Brooklyn Law School in Brooklyn, New York. “The best case scenario would be a couple where the breadwinner is also the one with the good credit score. Dropping the other spouse from the application is likely a no-brainer in that circumstance. And of course, there will be a gray area for a couple where both spouses bring in a significant share of the income. In that case, the couple should definitely shop around for lenders that can work with them.”