Let’s say you decide it’s time to buy property but you don’t have the scratch. What do you do? One option is to buy a house with a friend. I can see the logic in that. It could make it easier to come up with the down payment and/ or the monthly mortgage payments. Plus (you tell yourself) it will be so much fun to jointly own property with your “bestus buddy.” It’ll be a regular project!
While there certainly are benefits, my experience tells me that when “amigos” buy property together they usually don’t stay “compadres” very long. As a result, I’m against the arrangement generally speaking. You’ll see why in a minute.
But if you are planning on going forward with this idea anyway, let’s talk about how to buy property with a friend with the least possible risk to you or to them. Here are all the issues you will face – and a few suggestions on how to deal with them.
Getting a Loan
It’s hard to get a loan from a bank these days and that’s especially true if you are buying the house with your chum. That’s because the lender looks at each of your credit records and makes the loan based on the worst credit score between you. Some people team up with another person specifically because one has a bad credit score. They can’t qualify for a mortgage on their own and need someone with a better score t0 put the ball in the basket.
Sadly, this tactic has some serious snags. As I said, the bank looks at the lowest credit score between you when they decide to grant the mortgage or not. If one of you can’t qualify for a loan, the only way to get the loan is for that person to stay off the deed and mortgage.
This maneuver might help you buy the house but it will lead to a host of other problems down the road. And it puts the person with a bad credit score who isn’t on the deed at a huge disadvantage. It’s far better to only partner with people who have similar credit scores.
Taking Title
The term “taking title” refers to how you are going to own this property. Most unrelated people who buy property together take title as “tenants in common”. This allows each owner to will their percentage ownership to whoever they want should they die.
If they take title to the home as “joint tenants” the entire property will pass to the surviving partner when one passes away. For married couples, that might be fine but this doesn’t usually work for friends. What if you and Sheila buy a home together. She certainly doesn’t want her share to automatically go to you and you don’t want your share to automatically go to her should either one of you pass away.
This is not to say that the tenant in common tactic is without problems. If you and Mary Jo buy a property under that arrangement, she might want her cousin Pete (who just got out of the penitentiary) to inherit her share of the house and move in should she pass away. Awkward. An LLC might be a better arrangement.
The Agreement
Once you agree on how you are going to take title to the real estate, you next want to figure out who is going to do what and who is going to get what and when. Real estate is a very long term investment and circumstances change. That’s why you must have a written agreement that spells out the rights and duties of each participant for as many contingencies as you can think of. Here are a few of the items your agreement should cover:
Who owns what?
Your agreement needs to spell out the percentage ownership. Unless it does so, the courts will consider you both 50-50 partners even if you buy the property as tenants in common.
Who gets what?
One of the benefits owning real estate is the tax deduction generated by the mortgage. Only one of you can claim that deduction. Who is it going to be? If you get the tax break, is your partner going to be compensated? How?
Who pays for what?
Do you know what it really costs to maintain a home? Outside of the daily supplies you’ll need like soap and light bulbs, there are annual expenses and non-recurring repairs that come up. Who pays for these items? What happens if one of the partners doesn’t have the money to fix the roof (during rainy season)? Work that out now and make sure it’s part of your agreement.
Who gets to do what?
Can your co-owner throw a shin-dig on a Tuesday night? Are you allowed to practice your sumo wrestling techniques with your pal Kato at 5 A.M. on Sunday morning? What about more mundane issues like pets and smoking? How about sub-letting? Can either party sub-let their space to someone else? Hammer these things out before you sign on the dotted line.
Who wears the pants?
Somebody has to be the final arbiter when hard decisions need to be made. Let’s say your carpets haven’t been replaced since Saturday Night Fever was first released. You want new carpets but your co-owner wants to put in hardwood floors. Who makes the final call? You might decide to use a neutral third-party to break that tie. Discuss it between yourselves and with the third party now before the party starts.
Who gets to refinance?
Either party to a tenant in common could take a loan based on their interest in the property. But that means both are stuck with a lien if the person who takes out the loan doesn’t repay it. That stinks…but it’s the way it works.
One way to protect against this calamity is to buy the place using an LLC. I mentioned this option above. This is a different form of ownership than a tenant in common. This arrangement makes it very hard for one party to mortgage the property without all the other co-owners’ consent.
Other questions that must be answered.
- What happens if you one of you wants to cash out?
- What happens if one of you passes away?
- What happens if one of you losses her job?
- What happens if one of you moves?
- What happens if one of you doesn’t make the payments or fails to keep the house in order?
If I bought a house with a friend, I’d make sure that if any of the above happened, one partner would have the right to buy the other out. If that wasn’t possible, I’d want the right to sell the house and divvy up the profits.
As you can see, when you buy a property with a friend, there are a myriad of ways to get tangled up. If you still want to go ahead, I would absolutely get an attorney to provide guidance on what type of arrangement to use. I’d also use the attorney to draft up the agreement and I’d make sure that the attorney has plenty of experience in such arrangements. There are just too many potential problems. Do not attempt this on your own Pilgrim. Get a lawyer involved post haste.
Do you have any war stories about buying property with a friend? Did anything good come out of it?
slug | sunkcostsareirrelevant.com says
I think it’s pretty critical to make that purchase through an LLC, esp. if it’s going to be used as a rental property. You need to protect against liability.