Co-signing FHA loan has strings attached

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Q: We have income that we are unable to document on our FHA loan application. We need to qualify for just $50,000 more than we are approved for. We have elected to have a co-signer, but we would like to have a co-signer release after 12 months of on-time payments built into the loan. We do not want our co-signer to have any ownership interest in the property and he will not be on the title. Is it possible to do this with FHA loans?

And if he co-signs on our FHA loan and is removed after 12 months of on-time payments, will he need to wait three years from that point before he can apply for his own FHA loan or could he apply immediately once removed?

A: It sounds like you read somewhere that everything in real estate is negotiable. Between a buyer and seller, virtually everything is — that’s true. But when it comes to getting a mortgage — and especially an FHA-insured mortgage — the adage must be flipped backwards: Nothing is negotiable. You’ve got to play by the FHA’s rules, not vice versa.

Mindset Management

Back to basics: The FHA loan is a loan made by a regular mortgage bank, but insured by the Federal Housing Administration, whose goal is to make sure homeownership is available to people who might have less-than-perfect credit or a down payment less than 20 percent. Accordingly, the FHA loan allows lending in some circumstances where a non-FHA-backed, conventional loan would not. However, in order for it to make sense to back these loans, the FHA requires that the borrowers, the properties and the ownership scenario comply with certain guidelines — actually, with a lot of guidelines — which minimize the risk of default. This is why FHA loans are thought to be paperwork-heavy: There are just a lot of i’s to dot and t’s to cross to seal the deal.

So, on your deal, the short answer is that you cannot negotiate your own custom co-signer arrangement with the FHA. Rather, you need to learn what the FHA guidelines are about co-signers, and decide whether that will work for you.

And, one more thing: Why on earth would a co-signer agree to take on all the potential liabilities of co-signing for your home, with none of the advantages or even protections of having his name on the title? It doesn’t pass the smell test, and I’d be surprised if it didn’t raise a red flag to your underwriter, who might become concerned that there was something fishy going on. FHA loan underwriters exercise a high degree of scrutiny and personal judgment; if something doesn’t seem right, they have the power (rightfully so) to nitpick your deal to death or even decline the loan.

Need-to-Knows

FHA loans do allow for a non-occupant co-borrower, but that person must be a blood relative or be able to demonstrate a long, family-esque relationship with the occupant-borrower (i.e. you), unless you plan to put 25 percent-plus down. In my research, the only FHA loans I found that allow for a co-signer — that is, a non-occupant who assists with qualifying for the loan and agrees to be fully responsible for repayment but is not on title — were refinance programs. In general, on an FHA purchase loan, all borrowers must sign the note and the deed of trust, and take title to the property, but you should double-check that with your mortgage broker. …CONTINUED

Neither the FHA nor your bank will allow any sort of special agreement by which on-time payments for a year will "release" your co-borrower. If you qualify for the loan using the co-borrower’s income and assets, then he’s in it for the duration of the loan. The only way to get your co-borrower off the loan will be to refinance into another loan for which you qualify without the assistance of the co-borrower.

Once you have a new loan, sans co-borrower, your co-borrower can be immediately eligible for another FHA loan — he doesn’t need to wait three years.

Action Plan

1. Get aggressive about documenting your income more thoroughly. We no longer live in a stated-income world, and whether or not you buy with a co-borrower now, you’ll eventually want or need to be able to document your income for mortgage purposes via tax returns, etc.

2. Get educated about the FHA guidelines for non-occupant co-borrowers and your particular lender’s overlay guidelines, as your lender’s rules might be even more restrictive than the FHA’s. Talk with your mortgage broker about what you can and cannot do.

3. Then decide whether you can make the non-occupant co-borrower arrangement work, based on the FHA guidelines. Don’t work yourself into a fit customizing a special agreement with your co-borrower that conflicts with FHA rules, because it’s just not going to happen. Do make sure your co-borrower is aware that he is fully responsible for repaying the loan, in the event anything stops you from making the payment.

Tara-Nicholle Nelson is author of "The Savvy Woman’s Homebuying Handbook" and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Ask her a real estate question online or visit her Web site, www.rethinkrealestate.com.

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