A self-employed individual wants to make a 40% down payment on a modest house. However, even though his income will cover the monthly mortgage payments, health insurance, and other expenses, he’s been turned down for a loan without a cosigner. What if a family member offers to be a cosigner?
Let’s say the family member (cosigner)has a good job but won’t be contributing any money toward the down payment or mortgage payments. The buyer plans on setting up a separate shared bank account that would cover at least a year to 18 months of expenses for the home, in case something happens to him. Therefore, the relative won’t be burdened. The buyer will also list that person as a beneficiary on the mortgage. This allows them to sell the house or live in it.
Some of the issues to consider, include the following with a cosigner:
- What’s the tax liability?
- What if the relative lives there and pays the buyer rent?
- What if the buyer refinances in the future to remove the cosigner?
- What about a revocable living trust? Is that a better option?
The best option is to speak with an experienced estate planning attorney to explain the specific options for a buyer’s situation. The prospective cosigning relative should do the same.
Inheritance. If the buyer wants the relative to inherit the house if he dies, he could include her as the property’s beneficiary in his estate plan or a transfer on death deed. It is important to remember that mortgages aren’t assets, so they don’t have beneficiaries. If the cosigning relative inherits the house, she typically wouldn’t owe taxes, provided the home isn’t in one of the six states that still have an inheritance tax (Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania). Those six states have laws that permit closer relatives to usually pay lower taxes than more distant relatives or unrelated friends.
Leaving Money for the Relative. The buyer also could leave money to pay the home’s expenses for a specific time. This is a better notion than a shared bank account (unless the relative insists on access as a condition of the loan). It’s best to minimize financial entanglements with people if you’re not married to them or legally or morally responsible for them.
Refinancing. Refinancing the loan should be a priority, instead of leaving the relative the loan or inviting her to be a tenant. A landlord-tenant relationship makes for a more complicated situation, and a relative could be tough to evict.
Reference: Los Angeles Times (July 30, 2017) “How cosigning a mortgage loan can bring big risks”