Cosigned students loans are the ultimate wild-card when it comes to mortgage calculations. In an ideal world, the monthly payments made on a loan you cosigned for are not counted at all. After all, someone else is making the payments on the loan. Why should their monthly obligation limit your ability to buy a house?
Unfortunately, the reality of the situation is often different from what you might want or even expect.
The Best Case Scenario
If you get all of your ducks in a row, it is possible that the student loan you cosigned for will not be used when calculating your debt to income ratio. For this to happen you will usually need to show two things.
First, you must show that the monthly payments haven’t been missed on the loan. Most lenders require at least 12 months of on time payments, but some could require more.
Second, and a bit more difficult, you must show that you haven’t been making the payments on the loan. That means if you cosigned on the loan for your child, you must demonstrate to the lenders satisfaction that your child has been making the payments with their own money. Some mortgage companies may just require a statement from the student loan lender showing that the bank account the funds came from belongs to the borrower. Others may want further documentation in place. This documentation necessary will depend the mortgage company you select.
Once you are able to show that the loan you cosigned for is current, and being paid by someone else, the mortgage company will ignore the monthly payment when calculating your debt to income ratio.
The Worst Case Scenario
The worst cosigner situation would be if the borrower fails to make payments. If you cosign a loan for a friend or relative, and they fail to pay back the debt, you are obligated to pay it off in their place. Running into this situation can destroy your mortgage application in two ways. First, the monthly payment that you now have to make each month will hurt your debt to income ratio and will limit or eliminate your ability to get a mortgage. Second, if the borrower misses payments, and you do not step in before it is too late, the late payments can show up on your credit report as well. A single late payment can put a big dent in your credit score.
Another Bad Scenario
Even if the borrower you cosigned for never misses a payment, it can still limit your ability to get a mortgage.
This comes into play most commonly if the borrower is still in school. Mortgage companies will see these loans on your credit report and panic a little. On one hand, you don’t currently owe any money on the loan, and in the future it should be paid by the borrower… but on the other hand, they have no way of knowing whether or not the borrower will actually make the payments. In that circumstance, mortgage companies have actually insisted upon a three-way call between you, the student loan lender, and the mortgage company. The purpose is to figure out the most you will have to pay each month if the student loan borrower fails to pay. The mortgage company will then use this larger figure for purposes of doing debt-to-income ratio math.
A Warning About Automation
These days many approval or denial decisions are made by a computer using a complex algorithm. The computer takes the information you provide, pulls your credit report, does some math, and you get an answer. This initial answer is subject to verification, but as the role of the computer grows when making credit decisions, the ability for borrowers to explain their role on cosigned loans gets more limited. Some computer programs may see that there is a monthly payment of $200 on a loan you cosigned for and count that obligation against you when making a credit decision. Unlike an actual person, you can’t explain the circumstances of that loan to the machine.
The Bottom Line
If you are thinking about buying a house in the near future, cosigning a student loan is probably a very bad idea, especially if you are worried about your debt-to-income ratio. Even in the best of scenarios it can be a bit of a headache, and there are many ways in which it is bad news.