You’re reviewing the loan file and notice a line item under liabilities that indicate John and Jane Smith are co-signers on their son’s car loan. What you’ve just uncovered is a contingent liability.
No need to raise the alarm or stop the file – there are just a few things to know about contingent liabilities before you give it your final approval.
What Is a Contingent Liability?
As we alluded to above, a contingent liability is a liability that the borrower in question may be responsible for repaying if a specific event occurs. In most cases, this specific event means the primary payer of the debt defaults on their payment, meaning the secondary payer is now responsible for payments.
When a borrower has such a liability, we say that they are “obligated” on that debt.
Contingent liabilities are not necessarily long-term. There may be instances where the liability in question is close to being paid off, so the contingent liability will have a short lifespan.
Types of Contingent Liabilities
When underwriting mortgages, there are two main buckets of contingent liabilities to be aware of. That’s because certain debts may be excluded from the borrower’s recurring monthly obligations and the debt-to-income ratio (DTI).
Non-Mortgage Debt Paid by Another Party
Non-mortgage debts include installment loans, student loans, revolving debt, lease payment, alimony, child support and other separate maintenance.
When a borrower is obligated on a non-mortgage debt and is not the party that is repaying the debt, the debt may be excluded from the total monthly obligations and DTI. The credit history needs to reflect that there have been 12 months of timely payments made.
Mortgage Debt Paid by Another Party
When a borrower is obligated on a mortgage debt and is not the party that is actually making the mortgage payment, the full monthly payment, interest, taxes, insurance and HOA dues (PITIA) may be excluded from the total monthly obligations and DTI. The party that is making the payments must be obligated on the mortgage.
For underwriting purposes, there can be no delinquencies in the past 12 months and no rental income may be used to qualify. The lender will need to provide 12 months of cancelled checks or bank statements from the other party that has been making the payments.
Other Things to Know
In both instances explained above, non-mortgage debt liability and mortgage debt liability paid by another party, the party making the payments may not be an interested party to the subject transaction (such as a seller or realtor). And, although the payments are being excluded from the DTI, be sure to include the mortgage debt in the count of financed properties.
For more specifics on how Fannie Mae and Freddie Mac handle contingent liabilities for single and multiple finance properties, be sure to refer to their Selling Guides.
If you have questions about contingent liabilities, feel free to reach out to your Regional Underwriter at 800-444-5664, Option 2.
Natalie Stokes is a Regional Underwriting Manager for Enact, with over 22 years of underwriting experience.
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