It’s not uncommon for parents or grandparents to call us about the possible impact on their personal taxes should they co-sign a mortgage with a child/grandchild. This has become increasingly common in 2020 with plummeting interest rates. It’s important to understand the obligations that come from agreeing to this as well as the possible negative impact on the cosigner.
Typically, someone is asked to cosign a mortgage for credit reasons; the individual looking to purchase a home has the financial means to do so but lacks the credit history for loan approval. The higher credit score and additional income created by adding a cosigner makes a loan more appealing to lenders and their underwriters.
When it comes to cosigners, mortgage companies are looking for a few key factors: low debt-to-income ratio, stable income, and a good credit score. An approved cosigner would appear on the mortgage application and other loan documents, but not typically on the property itself. In other words, the cosigner does not generally have rights to the property. They do, however, have an obligation to ensure that payments are made timely. This means that if the primary mortgage holder fails to make payments, the bank will look to the cosigner.
There are a few concerns that a cosigner should keep in mind before signing on the dotted line. First, there is a risk to the cosigner’s credit score. If payments go unmade, this will negatively impact the cosigner’s credit in addition to the primary mortgage holder’s. Next, the cosigner’s debt to income (DTI) ratio is affected. Even though the cosigner is unlikely to be responsible for making the mortgage payments, on paper the mortgage will appear as a liability for the cosigner. Should the cosigner find him or herself in need of a loan, lenders will see the DTI as less attractive. There is also the risk of creating a tense situation amongst family members. If you decide to cosign for someone, we highly recommend that you have a very frank, business conversation about the realities of this agreement and possible outcomes.
What about taxes?
In short, you can cosign a mortgage without creating any impact on your personal taxes, though there is a risk to your credit and personal expenses. However, for tax treatment, if your child takes sole responsibility for the home and expenses and your name is only on the mortgage as a formality, he/she can claim all the tax deductions from mortgage interest and property taxes paid. Additionally, when the property is sold, all the proceeds from the sale can be solely on his/her return, thereby creating zero tax impact for the cosigner (so long as the seller maintained the property as a primary residence).
Alternatives to cosigning
Do you still want to help your child or grandchild purchase a home but find yourself unwilling to take on the risk of cosigning a mortgage? There are a few alternatives:
Hold the mortgage yourself. Some potential cosigners have the financial means to purchase the home themselves. They could then rent the home to their child or owner finance the property until the child has the financial means to purchase it from the parents.
Down payment or closing cost assistance. Sometimes a less than ideal credit situation for the purchaser can be remedied by increasing the closing costs contribution or down payment. Often, however, the purchaser lacks the additional cash to do this. Instead of cosigning, a parent could gift the additional funds to the child. Remember that some gifts may create a need for a Gift Tax Return. Alternatively, the parent could loan the child the additional funds. Be sure to check with your financial advisor or CPA for specific rules and regulations regarding family loans.
There are important legal factors that should be considered before entering into this type of agreement. What happens if one party passes away? Who inherits the property? Can the deceased’s estate be targeted by the mortgage holder? What about different types of ownership? Does one make more sense than the others? Consult with your CPA, attorney or real estate professional to discuss how you could be affected.