All About Co-Borrowing and Co-Signing

Perhaps the majority of borrowers obtain mortgages with a partner, or co-signer. Despite this, there is a tremendous amount of uncertainty regarding rights, responsibilities, etc. when more than one borrower is involved.  Allow me to offer some clarity.

First, let’s review the terminology. Co-borrowing refers to the issuance of a mortgage loan to two (or more) borrowers, both of whom share equal (legal) responsibility for fulfilling the terms of the loan. If they are not relatives, co-borrowers must cohabit the property that is being mortgaged. If related/married, it doesn’t matter whether they live together. Co-signing, meanwhile, refers to a situation in which a third-party “vouches” for the primary borrower(s); while it is understood that the co-signer does not bear primary financial responsibility for repaying the loan, he still will be held legally liable in the event of default. Anyone – relative, friend, etc. – can co-sign a loan for someone else.

In most cases of co-borrowing, the lender will use the lower credit score to determine the terms of the loan. This can become awkward, if one of the borrower’s scores is vastly higher than the other. While one might be tempted to simply drop the borrower from the loan application altogether (to prevent the bad credit score from affecting the loan terms), this will also reduce the amount of income that the borrowers can claim, and hence lower the amount of funds that they can borrow. The only solutions to this problem are to either go ahead and drop the borrower’s name (if you can afford to do so), or to petition your lender to use the credit score associated with the higher-income borrower (this assumes that the higher-income borrower also boasts the higher credit score).

The main pitfall of co-borrowing is a separation/divorce prior to the maturity of the loan. Again, this can become awkward, especially if such a contingency agreement wasn’t drawn up in advance. For that reason, all co-borrowers are encouraged at the time of obtaining the mortgage to draw up plans for resolving such a situation. It should account for both the possibility of a sale, as well as the alternative possibility that one borrower will continue to reside in the property. Under a sale, borrowers should determine how proceeds will be distributed. Without a sale, it must be determined (ideally in advance) whose responsibility it will be to repay the mortgage and how the borrower who continues to live in the house will compensate the borrower that no longer does.

Co-signing is also fairly straightforward when everything goes as planned. Bringing in a co-signer with a better credit score can not only boost one’s chances of being approved for a mortgage, but can also lead to better terms and a lower rate. The pitfall, of course, is the possibility that the borrower will not be able to fulfill the obligations associated with the loan, in which case the co-signer will be liable. The best way to guard against this possibility is to insist on the creation of a reserve fund (funded by the borrower and to be drawn from in a time of distress), and simply to only co-sign a loan for someone who you believe can repay the loan and/or you don’t mind assuming responsibility for if he can’t.