If you can’t qualify for an FHA loan on your own, you may have one more option. You may be able to use a non-occupant co-borrower. In other words, someone may be able to go on the loan with you, but not have to live in the home. This is despite the FHA rules that borrowers occupy the property. In reality, the rule states that at least one borrower must occupy the property.
Who Can be a Non-Occupant Co-Borrower?
In general, the FHA prefers if non-occupant co-borrowers are relatives. They could be blood relatives or relatives by marriage, though. This includes parents, stepparents, aunts, uncles, and children. However, the FHA does grant exceptions for co-borrowers that are not related as well. You just have to be able to prove that there is a long-standing, almost family-like relationship between the two of you.
How Much Can you Borrow?
Luckily, just as one borrower can borrow as much as 97.5% of the value of the home, so can one borrower and a non-occupant co-borrower. However, there is one restriction. If you have a borrower that does not live with you and you borrow more than 75% of the home’s value, you can only purchase a single-unit property.
This isn’t a big deal in most cases, though. A single-unit property includes single-family homes, condos, and townhomes. The only type of property that might be excluded would be a 2, 3, or 4-unit property. If you need someone to sign on the loan with you, though, chances are you would only be buying a single unit property in the first place.
How Co-Borrowers can Help
Many people mistakenly think that co-borrowers help them get approved if they have bad credit. This isn’t the case, though. Unfortunately, for any loan program, lenders take the lowest middle FICO score from each borrower’s three scores. Here’s an example:
John has 590, 600, and 605 credit scores
Jane (the non-occupying co-borrower) has 680, 690, and 695 credit scores
John’s scores are on the low side, even though the FHA only requires a 580. Most lenders want higher scores. John gets Jane to sign on the loan with him, thinking her higher scores would get him approved. However, John’s middle score is 600 and Jane’s is 690. Lenders will use the lower of the two scores, which is John’s 600. This could leave John without a loan.
How co-borrowers can help is with the debt ratio/income. If a borrower does not make enough money to keep the debt ratio low enough, a co-borrower can help. Let’s look at another example:
John makes $3,000 per month and his total debts including the new mortgage equal $1,500 per month. That’s too high to qualify for an FHA loan.
John asks Jane to be his co-borrower. Jane makes $5,000 per month. Jane also has $1,000 in monthly debts. Adding the two together, including Jane’s debts, the new debt ratio equals:
$2,500(total debts)/$8,000 (total income) = 31.2%
This 31% debt ratio would work much better for the FHA loan approval John is trying to get.
The Difference Between a Co-Borrower and Co-Signer
There is a difference between a co-borrower and co-signer. The co-borrower is on the title for the property. In other words, they have ownership rights. A co-signer does not go on the title and does not have ownership rights.
While both parties would be responsible for the loan payments if the borrower defaulted, the co-borrower is in a better position. If the borrower completely defaults on the loan, the co-borrower could try to sell the property. This way he is not liable for the payments any longer. A co-signer, however, does not have that right and is stuck making the payments or risking damage to his credit score.
The FHA loan offers many flexibilities, including the use of a co-borrower. If you can’t get approved on your own, finding a willing family member could help your situation. Of course, as is the case with any other situation, you should give careful thought as to who signs the loan with you. Allowing someone on the loan with you gives them right to the property as well. Make sure both parties are on the same page and understand the ownership agreement before making any decisions.