Danger Zone: Co-Signing Part I

Want to live on the edge? Want to wake up one day to find your financial world in disarray? Here is the recipe: co-sign on a loan.

Danger #1: payment is not made on-time

Father tempts fate, co-signs with son on car, safeguards himself by requiring son to set up automated payments, these payments do not go through properly despite the money being in the bank, car loan reports 30 days late. Credit score declines significantly. Tempted fate one, co-signing father zero, father now spends his days on the phone trying to right the wrong with the automotive lender and the bank the money was supposed to be automatically withdrawn from. Tempted fate two, co-signing father zero, as father wastes his time and encounters massive frustration trying to right the wrong.

If I co-signed for someone, which would probably be limited to my children, I would have them write the check to the creditor, give it to me, and I would send it in. I would also login online or call the automated phone system to make sure the check was good, just to make sure the payment has officially been made. Slightly anal behavior? Yes. Smart? Absolutely.

Danger #2: too much monthly debt lowers what I can qualify for when I need to borrow money

Why not just have my co-signed obligor give me the cash so I can pay it myself. Wouldn't that be easier? It would be easier, but there is a specific reason I would not do that. Debt-to-income, all monthly debt payments owed on my credit report count against my debt-to-income ratio, which translates into this: the more monthly payments I show on my credit report the less I qualify to borrow right now.

This impacts how much of a mortgage a home buyer would qualify for. The reason I want my co-signer to write a check to the creditor is because I want to be able to prove they have paid the monthly payment on their own, from their own checking account (meaning their funds, not mine), and I need the past 12 months cancelled checks to prove this, resulting in the debt being excluded from my debt-to-income ratios when I apply for a mortgage. Let's look at an actual dollar difference by playing make-believe:

Income $60,000/12 = $5,000 gross monthly income

Total debt-to-income ratio $5,000 x 45% = $2,250 (all debts including mortgage should fall inside this amount, the actual ratio ranges from 36% - 50%, I am using 45%)

Debts include car payment of $450, credit card minimum payments $150, co-signed student loan $200, and co-signed car loan $350.

Total debts with co-signed debt = $1,150

Total debts without co-signed debt (because the debts are paid by whoever the other co-signer is for the past 12 months, out of an account in THEIR name that has no trace of MY name, and can be proven with cancelled checks or automated payments shown on 12 months bank statements) = $600

$2,250 - $1,150 = $1,100 for a mortgage payment with the co-signed debt

$2,250 - $600 = $1,650 for a mortgage payment without the co-signed debt

Purchase difference? Assuming monthly taxes of $150, homeowners insurance of $50, and mortgage insurance of $150, and a rate of 3.25% fixed for 30-years:

Taxes and insurance = $350

With co-signed debt $1,100 - $350 = $750 Principal & Interest = $172,332.06 mortgage amount

Without co-signed debt $1,650 - $350 = $1,300 Principal & Interest = $298,708.90 mortgage amount

A difference of $126,376.84, just due to co-signing, voluntarily being saddled with more debt, wow, what a difference, and how disappointing for the person who cannot get what they want because of co-signing.

Do you see the dangers of co-signing just based on debt?

Do it right, if you co-sign make sure the payment is made by the other party from their account by a means that can be documented for the past 12 months, and finally, is paid on-time every month.

Read more about co-signing in Part II.

Have a mortgage or credit question you would like for me to cover on this blog? Shoot me an email so I can address it. If you want to apply for a mortgage for purchase or refinance in Arizona give me a call at 480-203-4641, the application process is easy, and it only takes 10 minutes for me to get the information to get you started on your way to home ownership.

Patrick Ritchie
Mortgage Finance Instructor

Ritchie School of Real Estate Finance

480-203-4641 Cell
Patrick@PatrickRitchie.com

NMLS# 276438 AZ#0913109
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