What Is an FHA Loan?

FHA loans, backed by the Federal Housing Administration, are designed to help low-to-moderate-income borrowers or those with less-than-perfect credit achieve homeownership. These loans offer flexible qualification criteria, including:

• A minimum credit score of 580 for a 3.5% down payment (or 500 with a 10% down payment).
• A maximum DTI ratio typically capped at 43%.
• The ability to purchase 1-4 unit properties, as long as the borrower occupies one unit as their primary residence.

However, if you don’t meet these requirements—such as having a high DTI or limited income—a cosigner can help strengthen your application.

What Is a Cosigner on an FHA Loan?

A cosigner is someone who agrees to be legally responsible for repaying the mortgage if the primary borrower fails to make payments. Unlike a co-borrower, a cosigner does not have ownership interest in the property and typically does not contribute to monthly mortgage payments unless the borrower defaults. The cosigner’s role is to provide financial backing by allowing their income, credit, and assets to be considered in the loan approval process. This can help the borrower qualify for the loan by improving the overall financial profile of the application.

For example, if you earn $4,000 per month with $2,000 in monthly debt (50% DTI), you may exceed the FHA’s 43% DTI limit. Adding a cosigner with $6,000 in monthly income and $1,500 in debt could lower the combined DTI, making approval more likely.

Who Can Be a Cosigner on an FHA Loan?

Not just anyone can cosign an FHA loan. The FHA has specific eligibility criteria for cosigners to ensure they can support the loan if needed. Here’s who qualifies:

• Relationship Requirements: The cosigner must be a family member (e.g., parent, sibling, grandparent, including step- or foster relationships) or a close friend with a long-standing, documented relationship with the borrower. If the cosigner is not a direct family member, you’ll need to provide proof of your relationship, such as letters or other documentation.
• U.S. Residency: The cosigner must live in the United States for most of the year.
• Financial Qualifications: The cosigner must meet FHA requirements, including:
  • A credit score that meets the lender’s minimum (typically 580 for FHA loans).
  • A DTI ratio that, when combined with the borrower’s, does not exceed 43% (or up to 70% with a down payment less than 20% in some cases).
  • Stable income and employment history, typically verifiable for at least two years.
• No Financial Interest: The cosigner cannot have a financial stake in the property, meaning they cannot be the seller, real estate agent, builder, or anyone who stands to profit from the sale. An exception exists if the cosigner is related to the seller by blood, marriage, or law.

For instance, a parent with a 700 credit score and $50,000 annual income could cosign for their child, but a real estate agent involved in the transaction could not.

Cosigner vs. Co-Borrower: What’s the Difference?

It’s important to distinguish between a cosigner and a co-borrower, as their roles and responsibilities differ significantly:

• Cosigner:
  • Does not have ownership interest in the property.
  • Does not contribute to monthly mortgage payments unless the borrower defaults.
  • Signs the loan agreement but not the security instruments (e.g., the deed of trust).
  • Their income, credit, and assets are used to qualify for the loan.
• Co-Borrower:
  • Takes title to the property and has ownership rights.
  • Is expected to contribute to monthly mortgage payments from the start.
  • Signs both the loan agreement and security instruments.
  • Their financial profile is also considered for loan approval.

For example, a spouse who will live in the home and share mortgage payments would typically be a co-borrower, while a parent who wants to help their child qualify but won’t live in the home would be a cosigner (often called a non-occupant co-borrower).

Benefits of Having a Cosigner on an FHA Loan

Adding a cosigner can provide several advantages for borrowers struggling to qualify:

• Improved Approval Odds: A cosigner’s strong credit, stable income, or lower DTI can help meet FHA requirements, especially if the borrower has a high DTI or limited income.
• Lower Interest Rates: A cosigner with excellent credit may help secure better loan terms, potentially saving thousands over the life of the loan.
• Access to Homeownership: First-time buyers or those with spotty employment or credit histories can use a cosigner to bridge financial gaps, making homeownership possible sooner.
• Flexible Down Payment: With a cosigner, you may still qualify for a 3.5% down payment on a single-unit property, though multi-unit properties (2-4 units) may require a 25% down payment if a non-occupant co-borrower is involved.

Risks of Having a Cosigner

While a cosigner can make homeownership more attainable, there are risks for both the borrower and the cosigner:

• For the Borrower:
  • The cosigner’s financial obligation could strain personal relationships if payments are missed.
  • The borrower remains fully responsible for payments, and defaults impact both parties’ credit.
• For the Cosigner:
  • Credit Impact: Missed payments or defaults by the borrower will harm the cosigner’s credit score, as the loan appears on their credit report.
  • Financial Liability: The cosigner is legally obligated to repay the loan, including late fees or collection costs, if the borrower cannot.
  • Impact on Future Borrowing: The cosigned loan counts as debt, potentially limiting the cosigner’s ability to qualify for their own loans (e.g., a mortgage or car loan).
  • Long-Term Commitment: A cosigner cannot be removed from the loan unless the borrower refinances into a new mortgage, such as an FHA streamline refinance, which can take years.

Before agreeing to cosign, both parties should discuss the risks and ensure the borrower can afford monthly payments. The Federal Trade Commission’s Notice to Cosigner, required for most loans, outlines these obligations clearly.

When Should You Consider a Cosigner?

A cosigner may be a good option in the following scenarios:

• High Debt-to-Income Ratio: If your DTI exceeds 43%, a cosigner’s income can lower the combined ratio.
• Limited Income: If your income is insufficient to qualify for the desired loan amount, a cosigner’s income can help.
• Spotty Employment History: Gaps in employment (unrelated to events like the COVID-19 pandemic) may disqualify you, but a cosigner with stable employment can strengthen your application.
• Limited Credit History: If you lack a robust credit history, a cosigner with strong credit can improve your chances.

However, a cosigner cannot compensate for a poor credit score. The FHA uses the lowest credit score among all parties (borrower and cosigner) to determine eligibility. If your score is below 580 (or 500 with a 10% down payment), even a cosigner with excellent credit may not help.

How to Add a Cosigner to Your FHA Loan

To include a cosigner on your FHA loan, follow these steps:

1. Choose a Qualified Cosigner: Ensure they meet FHA eligibility criteria (relationship, residency, financial qualifications).
2. Discuss Responsibilities: Have an open conversation about the risks, obligations, and expectations. Confirm the cosigner can afford to cover payments if needed.
3. Gather Documentation: The cosigner must provide proof of income, employment, credit history, and, if not a family member, evidence of a long-standing relationship.
4. Work with a Lender: Contact an FHA-approved lender to review your application. Some lenders may have stricter requirements than the FHA, so shop around for one experienced with cosigners (avoid lenders like Rocket Mortgage or Wells Fargo, which may not specialize in FHA loans).
5. Complete the Application: Both you and the cosigner will need to sign the loan application. The cosigner does not sign the security instruments, as they do not take ownership of the property.
6. Plan for the Future: Discuss a timeline for refinancing to remove the cosigner once your financial situation improves, reducing their long-term risk.

Alternatives to Using a Cosigner

If a cosigner isn’t the right fit, consider these alternatives:

• Add a Co-Borrower: A co-borrower who will live in the home and share payments may be a better option, as they have ownership interest and a more equal role.
• Improve Your Finances: Pay down debt, boost your income, or build your credit to qualify independently.
• Explore Other Loan Programs: FHA, FNMA HomeReady, or FHLMC Home Possible loans offer flexible terms for low-to-moderate-income borrowers, potentially eliminating the need for a cosigner.
• Down Payment Assistance: Look into state or local programs that provide grants or loans for down payments, reducing financial strain.

Key Considerations for Cosigners and Borrowers

Before proceeding with a cosigner, keep these tips in mind:

• For Borrowers:
  • Ensure you can afford monthly payments to avoid straining your relationship with the cosigner.
  • Get pre-approved before house hunting to understand your budget with the cosigner’s support.
  • Research state laws, especially in community property states, which may affect loan obligations.
• For Cosigners:
  • Verify you can afford to cover payments if the borrower defaults.
  • Understand that the loan will impact your credit and borrowing capacity.
  • Request a budget from the borrower to confirm they can manage payments.

Conclusion

Having a cosigner on an FHA loan can be a game-changer for borrowers who need help qualifying due to income, DTI, or employment challenges. By leveraging a cosigner’s financial strength, you can increase your chances of approval and potentially secure better loan terms. However, both parties must carefully weigh the risks, including the cosigner’s long-term financial liability and potential credit impact. Open communication, thorough planning, and consultation with an FHA-approved lender are essential to making this arrangement work. If you’re considering a cosigner or exploring other FHA loan options, contact a mortgage professional to guide you through the process and turn your homeownership dreams into reality.