I have seen more and more situations where someone has co-signed on a mortgage loan so that a family member could purchase a house or condo. Usually it is a parent who is co-signing for an adult child who has had credit issues. Typically, the parent has income, assets and a credit score that allows their child to qualify for a mortgage.
There are five important things that the parent or other co-signer must consider before agreeing to co-sign on a mortgage loan.
The first thing that someone co-signing must understand is that they are just as liable for the loan as is the person moving into the property. And since the other person did not initially have the income or assets to qualify on their own, it is likely they are not going to be collectible if something happens to the property. For example, if the mortgage is foreclosed, and there is a deficiency remaining after the foreclosure, then the parent can be held completely liable for that deficiency. A parent with significant savings or investments may lose them to garnishment if their son or daughter does not make payments on the mortgage. And since there was some reason that the child stopped making the mortgage payments, the bank is more likely to try to collect from the parent who had good assets and a good credit score.
Second, if the child falls upon tough times and the property is listed for a short sale, again the bank will look to the parent’s assets when deciding whether to forgive any deficiency. It is possible that the bank may require the parent to pay all or a portion of the deficiency to approve a short sale.
Third, if the debt is forgiven in a short sale or foreclosure, the parent may have tax consequences. The forgiveness of debt is a taxable event. And although many times the income is exempt from taxation, the largest exclusion from income does not apply for a property that is not the borrower’s primary residence. Therefore, it is possible that if the property is foreclosed or short-sold, it may cause a taxable event for the co-signing parent.
Fourth, the loan will be reported on the co-signor’s credit report and may adversely affect their credit score.
Finally, if the property is a condominium, the co-signing parent may be held financially responsible for any unpaid condominium dues. Again, this may result in the garnishment of checking, savings, or securities accounts.
Before agreeing to co-sign for any loan, make sure you understand the risks involved. The bank has all of the rights to collect from the co-signor. Make sure you properly consider these possibilities, before making the significant financial decision.