FHA loans are for owner-occupied properties only. What happens if you can’t qualify for the loan on your own and need a non-occupying co-borrower, though? Does this violate the FHA’s rules?
Luckily, you can get the help of a willing relative who will become a borrower on the loan. This person is not obligated to live in the home at any time. As long as one of you satisfies the owner occupancy requirements, it meets the FHA standards. In other words, one borrower must occupy the property within 60 days of the closing date. This borrower must also live in the home for at least the first 12 months. You will sign a statement stating this is the case at your closing. Opting to not live in the property could be considered mortgage fraud.
The Co-Borrower is Liable for the Debt
Just like when someone co-signs a personal loan for a borrower, the co-borrower is liable for the debt. In other words, if you don’t make your payments on time, the non-occupying borrower is liable for the debt. This could hurt his/her credit if you continually don’t make your payments. The lender can start to come after the co-signer for the money.
Non-Occupying Co-Borrower Requirements
The FHA has strict requirements for the non-occupying co-borrower including:
- You must take title to the property
- You must sign all mortgage documents at the closing including the security instruments
- You cannot have a financial interest in the property (you can’t be the seller, real estate agent or builder)
- You must be a resident of the United States with a principal residence established
Reasons to Use a Non-Occupying Co-Borrower
The most common reason borrowers use a non-occupying co-borrower on an FHA loan is lack of funds. If you don’t have enough income to qualify for the loan on your own, you can use the income of a loved one to quality. Again, this person must have their own residence established.
In order to determine if you would need a relative’s income, consider your debt ratio. The FHA has flexible debt ratio guidelines. Your total housing payment shouldn’t exceed 31% of your gross monthly income. This includes the principal, interest, taxes, homeowner’s insurance, and mortgage insurance. Your gross monthly income is the money you make before taxes are taken out.
Your total debt ratio is all debts you pay each month, including the new housing payment. Think of credit cards, personal loans, auto loans, and student debts. The minimum payment on each of these gets added to your housing payment. This total cannot exceed 43% of your gross monthly income.
If you don’t meet these guidelines, using the help of a loved one’s income may be beneficial.
Only certain relatives qualify as a non-occupying co-borrower. However, the list is rather lengthy:
- Blood relatives – Parents, children, siblings, aunts, uncles, nieces and nephews
- Relatives by marriage – Spouse, step-children
However, you may be able to use someone not technically related to you if you can prove your relationship. The longer you have known the person, the more likely it is the FHA will allow it. For example, if you have someone in your life you consider an ‘aunt’ who really isn’t related by blood may count.
If you can prove you have a distinct relationship, you may qualify for the standard FHA loan with only a 3.5% down payment. This means you can borrow 97.5% of the purchase price.
If you have a co-borrower that doesn’t meet the guidelines, you may qualify for the loan with this person, but you may only get 75% financing. In other words, you’d need 25% down, which negates the benefits of using FHA financing in the first place.
The Co-Signer Difference
A non-occupying co-borrower may sound just like a co-signer, but there is a major difference. A co-signer does not have a vested interest in the property. They do not sign the security documents. However, they are still liable for the debt if you default.
In most cases, the co-borrower is in a better position. If you default on the debt, the person with ownership in the property has a better chance of selling the property. This can decrease the risk of financial ruin if they have to take over the mortgage payments. Co-borrowers don’t always have an easy time selling the property, but they can secure legal assistance if it is necessary. A co-signer has no rights in the property and cannot sell it, even with legal help.
Before you decide to use a non-occupying co-borrower, it is very important that you give it careful consideration. First, you are giving up a part of the interest of the property. You should only consider this with a relative you are close with and can trust. You are also putting this relative’s credit history at risk. They take a legal obligation to pay the loan. This affects their credit score as well as their debt ratio if they decide to apply for any new credit in the future.
Having someone help you buy a home by using their income to qualify can be a very beneficial situation. But, it has the opportunity to go very wrong. Make sure you work out all of the details with this person so that everyone is on the same page with one of the largest investments you will make in your life.