Even when everything goes right with a cosigned student loan, there can be negative consequences for the cosigner.
Cosigned student loans can be a considerable hurdle on a mortgage application. In some cases, it can be the reason for a denial. For other applicants, a cosigned student loan can mean a smaller house.
Minimizing the impact of a cosigned student loan can require a bit of paperwork. In many cases, the cosigner can overcome the negative consequences of helping someone borrow a student loan.
Why cosigning student loans is a problem: The Debt-to-Income Ratio (DTI)
Cosigned student loans appear on credit reports.
Unfortunately for consumers, the credit report doesn’t clearly identify someone as a cosigner or as a primary borrower. Additionally, most lenders don’t particularly care. If a borrower could be responsible for paying off the debt, the initial assumption is that the borrower will be responsible for paying off the debt.
While there ways to change the initial assumption (more on those in a bit), the problem is that so much of the underwriting process is done by a computer.
There is a formula for deciding whether or not an applicant is approved. There is a formula for determining how much someone can borrow for a mortgage. A cosigned loan will impact these formulas.
The loan on the credit report will show that the person is responsible for paying X dollars each month. This monthly obligation will affect the applicant’s Debt-to-Income ratio (DTI). The more debt on someone’s application, the more income they will need to afford the requested monthly mortgage payment.
Removing cosigned loans from mortgage application calculations
The good news for cosigners as mortgage applicants is that the cosigned student loan can be excluded from the calculations. The downside is that the process can be a bit tedious.
Simply explaining that the student loan on the credit report is cosigned isn’t enough. Lenders will often require applicants to send proof that the primary borrower is making payments on the loan. They may require documentation showing timely payments made for the past 12 months or more.
Additionally, the primary borrower may have to demonstrate that the cosigner is not the one making the payments.
The exact underwriting procedure can vary from one lender to the next. Mortgage applicants should be prepared to provide plenty of documentation showing that the primary borrower has been able to make payments on their own and that the primary borrower will be able to continue to make payments.
Removing a cosigner from the student loan
Rather than convincing a mortgage company to ignore a student loan on the credit report, a more effective approach may be to get the cosigner removed from the student loan.
There are several different ways to remove a cosigner from student debt:
Cosigner Release – Many student loan lenders have cosigner release policies. If the borrower makes payments for a certain period (usually 12-36 months, depending upon the lender), and the borrower passes a credit check, the cosigner can be removed. 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 old cosigned loan is paid off in full, and a new student loan, ideally without a cosigner, is created. The primary borrower may be able to get a lower interest rate or lower monthly payments by refinancing. The cosigner will no longer be liable for the debt, and it will fall off their credit report once the refinance is finalized.
Refinancing with a New Cosigner – When refinancing a loan, there is no requirement that the cosigner stays the same. Having a cosigner on the loan will probably be necessary if the primary borrower is unemployed or has a negative credit history.
Regardless of the approach used to remove the cosigner, mortgage applicants should 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 the cosigners who have primary borrowers that are still in school, the options are more limited.
Cosigner releases will rarely be granted, and refinancing usually isn’t an option for in-school students. Additionally, 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 for the student loan. When this happens, some mortgage companies will use 1% of the loan value as a stand-in for the monthly payment. Other mortgage companies have been known to set up a three-way call between the applicant, the mortgage company, and the student loan company to 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.
This situation is one of the reasons that cosigning student loans should be avoided if the cosigner may be looking for a new house before the borrower graduates.
Cooking the books
The total amount of debt doesn’t really matter for most DTI calculations. Instead, it is the monthly payment that is used.
This provides an opportunity for tweaking monthly payments in order to minimize the impact of cosigned debt on mortgage applications.
There are two primary ways to lower payments:
Have the borrower change repayment plans – Many student loans have multiple repayment plans that a borrower can select. By choosing a longer repayment plan, the monthly payment will be lower, because repayment is spread over a longer period. The lower monthly payment could help the cosigner with their mortgage application.
Refinance the debt with the cosigner – In an ideal world, the cosigner wouldn’t participate in the refinanced loan, so the debt would be erased completely. 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
While there are several different strategies to address cosigned student debt on mortgage applications, there is one common issue: time.
No option will immediately fix the issue, and many of the options described can take up to several months.
Student loan cosigners should get into contact with the primary borrower as soon a possible to discuss a plan. Those that have already started the mortgage process will want to work with their mortgage company to ensure things go smoothly.