“Get a cosigner – You can always refinance to get them off in 6 months” is a refrain commonly used in the real estate industry.
While these 7 words… ‘You can just refinance in six (6) months’, sound good to the buyer and potential co-signer alike, and go a long way to move the sale along- they set the foundation for family feuds, strained or broken friendships, financial hardships and even lawsuits.
These 7 words take away from the ability of your borrower and co-signer to plan an effective exit strategy from the cosigned obligation they are entering, and can potentially erase any trust you as a real estate sales professional worked so hard to build and destroy any prospect of future referral income from your buyer and co-signer.
So why are these 7 words so loosely used within industry? After all, the overwhelming majority of sales agents are not looking to intentionally mislead their customers. The answer to the question can be rooted in the lack of understanding of what would be needed from a borrower seeking refinancing at such an early stage, and what would need to change in the borrower’s profile from the mortgage underwriting perspective.Here are 4 reasons why a successful refinance is unlikely at such and early stage:
Reason#1: Not Enough Equity in the HouseYes. A rate-term refinance can be completed at the six month mark. However, the new appraised value would need to have increased enough to absorb a second set of closing costs and maintain the required loan to value ratios. Loan to Value (LTV) are based on closed comparable sales within a 1 mile radius of the property over the most recent 4-6 month period . So chances are the same closed sales will be used for the initial purchase are the same ones that will end up being used on the refinance. So unless the buyer purchased well below market, – a large equity down- payment was made at contract, – or the neighborhood experienced a spike in closed sales prices- there simply would not be enough equity in the property to complete the transaction.
For the math junkies out there here is an example: (For others – skip to Reason #2)
A buyer makes a $500,000 purchase at 95% financing ( 5%- down), making her initial loan amount of $475,000. If in six months she wants to refinance the cosigned loan, she would need a new loan of $498,750. The new loan amount needed is inclusive of a 5 percent closing cost of $23,750. ($475,000 *5%) + the original loan of $475,000. If the initial appraisal was equal to purchase price, – at least two closed comparable sales at $525,000 or above would be needed just to maintain the initial 95% LtV financing. If there are no sales at that higher value, our borrower would need to bring hard cold cash to closing in the amount of $26, 750 to reclose the mortgage.
Reason #2: Hard and fast underwriting Equity-buyout rule
If our borrower used a co-borrower and not a co-signer ( See our article outlining the difference), and said co-borrower is on title and is to be removed at the closing table through an equity- buyout transaction – there is a hard 12-month seasoning requirement by the major underwriters – Fannie Mae. Freddie Mac and FHA which says quite plainly that BOTH parties must be on the deed jointly for a 12-month period before such a transaction can be completed. Similarly, if the borrower wants to pay off the co-signed loan and cash out additional funds for home improvements or other expenses , the 12-month waiting period also applies. ( Yes – even if the house is appraised triple the price)
Reason#3: Not enough Borrower Income to go it alone.
If a co-signer was added for income purposes, it is highly unlikely the main borrower’s income would have increased enough in 6 months to allow them to qualify on their own. Hourly wage earner income is always calculated based on previous 1 0r 2 year(s) plus the Year-to-Date earnings. The extra income earned over the additional six- months generally will not have enough of an impact to significantly affect the debt-to-income ratios. The single exception is for a salaried employee whose salary income has significantly increased by the 6 month mark.
Reason #4: Not enough time to improve Credit
Co-signers are not typically added for higher credit score purposes only. Guidelines require the use of the lower of the middle credit score across all borrowers. If however, a cosigner was added in place of an intended applicant who was unable to get on the loan due to credit score, the omitted person must be diligent in getting their scores corrected. Special caution must be exercised here. Depending on the reason for the low score of the omitted applicant, underwriting guidelines may call for a set waiting period after the derogatory event. This is the case for bankruptcies ( 2 to 4 years) , foreclosures ( 3 to 7 years) and short sales ( 1 to 3 years) from the last reported date of the derogatory event on the credit report.
Bottom line – set the correct expectations for your borrower and cosigners.
As sales professionals we are in the business of service to our customers. Great service includes providing the proper information to our customers so that they can make informed decisions. It is great for long term business for all involved. The potential long-term damage to the customer, the cosigner and your online reputation is certainly not worth any short term compensation. Take the time to review the specifics reasons a cosigner is needed with your loan originator. Be sure that your buyer and your co-signer have a clear understanding of what is involved and the timeframe required for the refinance out of a loan utilizing the cosigner. For more information on utilizing a cosigner visit us at: www.channelmtg.com/chatwithaloanofficer.