Even when a borrower manages a cosigned student loan well, there can still be negative consequences for the cosigner. This is particularly true when it comes to mortgages.
Cosigned student loans can be a considerable hurdle on a mortgage application. For some applicants, they can lead to higher interest rates, a lower total qualification, or even an outright denial.
Minimizing the impact of a cosigned student loan can require a bit of paperwork. In many cases, however, the effort can help the cosigner overcome the negative consequences.
Why cosigning student loans is a problem: The Debt-to-Income Ratio (DTI)
Cosigned student loans show up on the credit reports for both the primary borrower and the cosigner. Unfortunately, these reports do not clearly identify the individual as one or the other. Moreover, most lenders don’t really distinguish between the two roles. They assume, at least initially, that if a borrower could be responsible for the debt, the borrower will be responsible for it.
While there are ways to challenge this assumption, a major hurdle is that much of the underwriting process is automated. Lenders use pre-determined formulas to decide whether to approve an applicant and how much the applicant can borrow. A cosigned loan will influence these formulas.
A cosigned loan adds to the monthly debt amount listed on the cosigner’s credit report. This, in turn, affects the cosigner’s Debt-to-Income ratio (DTI). Consequently, the more debt listed, the more income the cosigner needs to qualify for the requested mortgage.
[Further Reading: Fixing Debt-to-Income Ratio Issues Caused by Student Loans]
Removing cosigned loans from mortgage application calculations
The good news for cosigners applying for a mortgage is that it’s possible to exclude cosigned student loans from their debt calculations. However, the process can be somewhat tedious.
Simply explaining that the student loan listed on the credit report is a cosigned loan usually isn’t enough. Lenders typically require proof that the primary borrower is the one making the student loan payments. For instance, they may require documentation showing timely payments made for at least the past 12 months. Additionally, the cosigner may need to demonstrate that the primary borrower is the one making the payments.
The specifics of this underwriting process varies from one lender to the next. Mortgage applicants should be prepared to provide comprehensive documentation that demonstrates the primary borrower’s consistent payment history and ability to continue making payments in the future. This will help in ensuring that the cosigned loan does not negatively impact the mortgage application.
Removing a cosigner from the student loan
Rather than trying to convince a mortgage company to overlook a student loan on the cosigner’s credit report, a more practical solution might be to remove the cosigner from the student loan altogether.
There are a few ways to remove a cosigner from student debt:
Cosigner Release – Many student loan lenders have cosigner release policies. Under these programs, if the primary borrower makes consistent payments for a certain period (usually 12-36 months) and passes a credit check, the lender may release the cosigner from the debt. Unfortunately, there is little incentive for student loan companies to actually grant these requests. Lenders prefer to have two people legally responsible for the debt instead of just one.
Refinancing the Loan – Primary borrowers with a decent credit score and a job may be able to refinance the student loan. Through the refinance process, the refinancing lender pays off the original cosigned loan in full. The refinancing lender then creates a new student loan, ideally without a cosigner. The primary borrower may be able to get a lower interest rate or lower monthly payments through this process. Additionally, if the primary borrower doesn’t need the cosigner for the new loan, the cosigner will no longer be liable for the debt, and it will eventually fall off their credit report.
Refinancing with a New Cosigner – When refinancing a loan, there is no requirement to use the same cosigner. Regardless, a cosigner will likely be necessary if the primary borrower is unemployed or has a negative credit history.
Regardless of the approach used to remove the cosigner, it’s essential for mortgage applicants to plan ahead. Getting approval for a cosigner release or a refinance can take weeks or even months. Additionally, it will take some time for the lender to report the cosigner’s change in status to the credit bureaus.
Dealing with students still in school
For individuals who have cosigned student debt for primary borrowers still in school, the options for alleviating the impact of the debt on their financial profile are more limited.
Lenders rarely grant cosigner releases for in-school students. Refinancing usually isn’t an option, either. Furthermore, because repayment hasn’t begun on the loan, the mortgage applicant won’t be able to show that the primary borrower can handle the loan on their own.
Often, the credit report will not even show a monthly payment amount for such loans. When this happens, mortgage companies will sometimes estimate the monthly payment to calculate the DTI. Typically, these companies will use 1% of the total loan value as a stand-in for the monthly payment. Other mortgage companies set up a three-way call between the applicant, the mortgage company, and the student loan company. They will determine what the maximum monthly payment on the loan might be. The mortgage company then uses the maximum possible payment for making DTI calculations and underwriting decisions.
These scenarios underscore why cosigning a student loan can complicate financial matters for cosigners, particularly those who might be looking to purchase a new home before the borrower graduates. Cosigners in such situations should be fully aware of these complications and consider their need for future credit before agreeing to cosign.
Cooking the books
Indeed, when calculating DTI for mortgage applications, the total debt amount is less important than the monthly payment amount. This focus provides an opportunity to adjust monthly payments to lessen the impact of cosigned debt on mortgage eligibility.
There are two primary ways to lower payments:
Change repayment plans – Many student loans offer multiple repayment options. If the primary borrower switches to a plan with a longer repayment term, the monthly payments will be lower because the debt is spread out over a longer period. This reduction in the monthly payment amount can help improve the cosigner’s DTI ratio, enhancing their chances of qualifying for a mortgage.
Refinance the debt with the cosigner – In an ideal world, the cosigner wouldn’t be involved in the refinanced loan, completely removing them from the obligation. However, when the borrower can’t get approval on their own, and no other cosigners are available, a refinance can still help. By refinancing with a lender offering a lower interest rate or longer repayment length, the cosigner can improve their mortgage application.
Getting started early
Indeed, while there are various strategies to mitigate the impact of cosigned student debt on mortgage applications, a common challenge across all options is time. None of these strategies will provide an immediate resolution, and many can take several months to effectuate significant changes.
It’s crucial for cosigners to contact the primary borrower as soon as possible to discuss and develop a plan. The sooner you start, the more time you have to implement a strategy that may help improve your financial standing for a mortgage application.
For those already in the process of applying for a mortgage, proactive communication with your mortgage lender is essential. Discuss the presence of the cosigned debt and any steps you’re taking to manage it. Some lenders may be flexible or offer guidance on how they handle cosigned debts in their DTI calculations.
Since adjusting the impact of a cosigned loan can take time, planning for potential delays in the mortgage approval process is wise. This might mean starting your mortgage application earlier than initially planned or preparing for a longer wait time before approval.
By understanding these timelines and starting discussions early, cosigners can better navigate the complexities of managing cosigned student debt when applying for a mortgage, thereby ensuring smoother transitions and clearer communications with all parties involved.
