If you co-purchase a home with a friend you’ll want to get everything in writing, including how much you’ll contribute and what happens if someone decides to sell.
Millennials have proven that marriage is no longer a prerequisite to homeownership. In fact, you don’t even have to be romantically involved with someone to go Dutch on a piece of real estate.
Between 2014 and 2021, the number of people with different last names who co-purchased a home in the U.S. increased by 771%, the Wall Street Journal reported. The trend is expected to continue as the pandemic drives home prices higher and mortgage rates stay low.
If you’re considering pooling money with a friend to buy a house to live in full time or to use as a vacation spot, here’s what you should know.
Get essential money news & money moves with the Easy Money newsletter.
Free in your inbox each Friday.
Buying a house with someone (or multiple people) that you don’t already share finances with can be tricky.
Before you start shopping, have an open and honest conversation about your financial status and your expectations for the partnership. Be clear about how much you can afford to contribute for a down payment, monthly mortgage payments, property taxes, insurance, and repairs and maintenance. If you’ve never lived with this person before, discuss your lifestyles to make sure they’re aligned.
If you plan to obtain a mortgage together, know that both buyers’ credit profiles will be under consideration and the lower score will dominate. Lenders will look at each person’s income and debt-to-income ratio.
Take time before applying for a loan to improve your credit scores and pay down debt. You can improve your credit by making credit and loan payments in full and on time and reducing the amount of available credit you use. Alternatively, the person with the higher credit score can apply for a single-applicant mortgage, but they won’t get the benefit of combining incomes to qualify for a higher loan amount. The good news is that if you’re both in solid financial standing, you may be able to get more favorable mortgage terms, such as a larger loan amount or a lower interest rate.
When it comes to paying the mortgage, one person can handle sending the payments, but both owners are legally responsible for the debt. That means if payments are late or missing, both people’s credit will take a hit and the lender has the ability to hound both people until they get their money.
A mortgage weighs heavily on a person’s finances, says Paul Sundin, an Arizona-based CPA and tax strategist at Estate CPA, so be sure to review each other’s financial situation seriously and deeply before getting tied up together.
When it comes to legal ownership, co-buyers who are not married typically choose one of two options during the closing process: joint tenancy or tenancy in common.
Joint tenancy grants rights of survivorship, meaning that if one co-owner dies, the other one will automatically inherit the deceased person’s share of the house. As joint tenants, you own the property equally, with each person getting a 50% share. If one person wants to sell their title, they have to get permission from the other person. Without their express consent to sell, you’ll have to take the issue to court.
Tenants in common own a property equally, but there are no automatic rights of survivorship. You may choose to divvy up the total value or physical aspects of the property according to how much each person contributes to the purchase price, monthly mortgage payment, or something else. When it comes to exiting the partnership, you don’t need permission from the other person to sell your interest in the home and if you die, your portion can pass to your chosen heirs or the co-owner if you choose.
Tenants in common is generally more flexible and therefore recommended by many real estate experts. “If a dispute arises, both arrangements may be difficult to get out of, but a joint tenancy is more difficult,” says Steven Katz, an attorney in Ohio.
Both of these arrangements can be used for a primary residence or a vacation home that’s going to be used by both owners. If you’re buying an investment property with a friend, however, you might consider setting up a limited liability company to shelter the property as a business asset. An LLC will make the ownership scheme more formal with a legally binding operating agreement and additional tax benefits for any rental income it generates.
Co-buyers should always consult a local attorney early in the homebuying process. “The most important thing is to protect yourself and to do so in writing,” Katz says.
Before signing an offer on a home, draw up a partnership contract that specifies everyone’s financial and administrative responsibilities. Include details like who will actually click submit on the mortgage payment each month and how much you’ll contribute to an emergency fund to cover expenses like a plumber or a new roof. Also address what happens if someone can no longer afford to pay their share or if a recession hits.
If you’re buying with a close friend, it may feel strange or unnecessary to be so formal. But having a written record of your mutual decisions only strengthens the partnership. Talk about your respective exit strategies too — what happens if one or both of you wants out of ownership? Write them down so there’s no ambiguity. This could save you both from additional stress if things turn sour.
“Even the most loved-up couples and the tightest of best friends may find themselves having to go their separate ways. And of course, death can come anytime, unexpectedly,” Sundin says.
Image: Johanna Dahlberg