For those buying their first home, the single biggest challenge is coming up with needed funds for a down payment, closing costs and cash reserves. One of the primary reasons FHA loans are so popular with first-time buyers is the low down payment of only 3.5 percent. Of that, the 3.5 percent can be a financial gift from a family member. FHA loans are also a bit more lenient as it relates to credit qualifying. Sometimes though that’s not enough help.
Sometimes first-time buyers don’t yet have enough income to qualify for a mortgage.
This is common when someone first gets out of school and has yet to find a permanent job or the entry-level job doesn’t pay enough. When that happens, the would-be buyers would either have to wait, save up more money or get someone to co-sign the note.
When co-signing, it needs to be clear to those helping out that the payment history on the new mortgage will be reflected on their own credit report along with the buyers. If payments are made on time, or at a minimum no more than 30 days past the due date, a positive entry on both credit reports will be logged. This will raise credit scores for all involved. Conversely, should there be a late payment made more than 30 days past the due date, that negative mark will show up on both credit reports and drive down scores. This can happen without the knowledge of the co-signers until its too late.
Co-signing also hits both parties with the same debt. If the total monthly mortgage payment is $2,000, then both the primary borrowers and the co-signers can expect the monthly debt to appear on a credit report. This could potentially affect the ability of the co-signer to take on new debt such as qualifying for a new mortgage to buy a home or even when refinancing. Deciding to co-sign demands some serious consideration.
As it relates to funds needed to close, family members can provide financial assistance in the form of a gift. This is common when parents want to help their kids buy a home. Parents can give the needed funds to close on a home with no expectation or requirement to be paid back. Gift funds must be accompanied by a letter stating as much along with a solid paper trail of where the funds came from and their ultimate delivery. Parents can decide to provide a certain amount up to and including needed funds to close on a property.
Funds can also be provided to pay off the outstanding debt of the primary borrowers. Perhaps paying off an automobile loan or student loan. In doing so, monthly debt ratios will be reduced enabling the buyers to qualify for the mortgage they want. A family member might also agree to provide a second mortgage on a property. Borrowing from a family member means making sure the note is valid in the state its executed and properly spells out the terms of the note. The first lien lender will also want to take a look at the new second lien note to make sure it complies with state law and indeed subordinates to the new first lien.
Co-signing is one of the more common ways family members can help first timers buy a home but they can also help in other ways that doesn’t obligate the parents to be a responsible backup to more debt.
Author David Reed (Austin, TX)
Author of Mortgages 101, Mortgage Confidential, Your Successful Career as a Mortgage Broker , The Real Estate Investor's Guide to Financing, Your Guide to VA Loans and Decoding the New Mortgage Market. As a Senior Loan Officer and Mortgage Executive he closed more than 2,000 mortgage loans over the course of more than 20 years in commercial and residential mortgage lending.
He has appeared on CNN, CNBC, Fox Business, Fox and Friends and the Today In New York show. His advice has appeared in the New York Times, Parade Magazine, Washington Post and Kiplinger's as well as in newspapers and magazines throughout the country.
Reed was the former Technology Chair for the Texas Mortgage Bankers Association, Board Member and President of the Austin Mortgage Bankers Association. He is married and a father of three in Austin.
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