Q: My best friend and I have been like sisters since we were 10 years old. We happen to both be house hunting in the same area at the same time — me with my husband, and she with her new-ish (but serious) live-in boyfriend. We stumbled across this super-cute duplex with mirror-image units. It wasn’t exactly what either couple was looking for, but the units would work well for both of our households, and we are each qualified for more than half of the price of the building. She and I trust each other implicitly, but the men in the group are wary of all four of us sharing a mortgage. What happens if someone fails to make their half of the mortgage payment?
There are lots of lifestyle and relationship considerations to take into account when considering a transaction like you describe — buying a place with your friends. This is a good point in time for you both to reflect on what your goals for home buying were in the first place and determine whether a shared ownership arrangement will further or hinder those aims. For example, many first-time home buyers look forward to the autonomy of ownership, such as being able to paint your house whatever color you want, playing your music however loud you want, and landscaping your home to suit your whims — all things that you won’t be able to do so freely if you buy a building jointly with your friend. Of course, many owners of condos and homes in planned developments give up such freedoms for the benefits of varying degrees of communal ownership and living arrangements — just do a check-in to be sure that you’re not compromising your vision of home ownership without making a conscious decision to do so.
1. Legal Ownership. In most states, the ideal legal ownership vehicle for your sort of transaction is called tenancy-in-common, or TIC for short. In a TIC, owners have the freedom to custom craft the details of the shared ownership arrangement to their precise desires; owners can own the property in any combination of percentages of ownership, and can negotiate their own rights and obligations vis-à-vis the property and each other.
In your situation, it sounds like the two couples would own the property 50/50. However, there are still lots of things to negotiate in terms of how common bills will be apportioned and paid; how the property will be maintained and repaired; rules and regulations for daily living (e.g., music, pets, noise-making activities, elective remodeling), etc. More importantly, you’ll need to specify the particular areas of the property to be exclusively used by each couple, the particular areas that will be shared, and any guidelines or restrictions on selling a unit.
All of the arrangements you negotiate must be reduced to writing, in a document called a TIC agreement — I beg you to hire an attorney to help you, your BFF and your respective sweethearts negotiate and document this agreement. A good TIC agreement may cost you a couple thousand dollars, but it may help you (a) know before you even close escrow whether the relationship can withstand the deal, and (b) avoid issues later by resolving them before they truly become "issues."
2. Mortgage. The TIC form of legal ownership allows you two mortgage options. First, you, your husband, your friend and her boyfriend can simply all apply for and share a single, regular old mortgage. You would all agree to joint and several liability — that just means that if the mortgage is ever not paid, each of you individually would be held responsible by the mortgage lender. For your purposes, that means that if your best friend and her husband ever failed to pay their half, you and your husband’s credit would be impacted, and your share of ownership in the home would be threatened — if the lender forecloses, it will foreclose on the entire property, even if you have paid your share.
The second mortgage option is a fractional ownership loan, also known as a TIC loan. Each couple would qualify for and commit to a mortgage separate from the other couple, and each mortgage would be secured only by that couple’s share of ownership in the property. So, if you defaulted on your mortgage and the bank foreclosed on your share (Heaven forbid), your friend and her boyfriend would keep their share, so long as they kept their separate mortgage current.
I wish it were as simple as just taking a fractional loan. But fractional loans also have major pros and cons — some of which may be deal-breakers for one or more of the parties involved:
- Rates and Terms. There are currently only about five banks in the country doing fractional loans — all of them located in or around San Francisco, but they will lend on properties nationwide. However, the lack of competition allows these banks to all charge significantly higher than market-rate interest for the major perk of fractional liability — currently almost a full point higher than a regular joint-and-several-liability loan. Also, most fractional loans have severe prepayment penalties, tempered only by the fact that they typically are assumable by a buyer with strong credit and down payment.
- Qualification Requirements. The TIC loans have much stricter qualifying guidelines than "regular" loans. All of them require a minimum 10 percent down payment, FICO scores near 700 (when a 600 can get you a regular loan), and very low debt-to-income ratios, meaning you can’t have much credit card, car loan or other debt and qualify.
- Resale Impact. Keep in mind that the tougher qualifying requirements of a fractional loan will cut down the numbers of potential buyers who can make the cut when you go to sell your unit — making it tougher to sell. On the current loan market, where there isn’t much zero-down financing, there won’t be that much of a difference between the loans available on the regular market and your fractional loan, but in times when mortgage money flows more freely, many buyers will walk past a place with a 10 percent down-payment requirement when they can easily buy another place with no money down. On the flip side, some TIC owners essentially use this 10 percent down-payment requirement as a guarantee that anyone who buys a unit will have some minimal level of financial stability.
- Get educated about TICs. The best Web site out there is by pioneering TIC attorney Andy Sirkin — www.AndySirkin.com.
- Get repped. Consult with and (eventually) retain a real estate attorney with experience helping co-owners negotiate and draft TIC agreements.
- Get quotes. Get interest rate, terms and payment quotes on both types of loans, from mortgage pros who have seen all four of your credit scores, income and asset statements. Tara’s Tip: Pull your own credit reports and FICO scores and ask the mortgage folks to preapprove you all with those, preventing multiple credit "pulls," which can reduce your scores.
- Get clear on the risks. Have a group conversation with your attorney about ways in which the risks of joint and several liability can be minimized without incurring the costs of a fractional loan. If everyone is cash flush, maybe a reserve account can be set up, and each couple can deposit several months’ worth of payments, to be used as a last resort to make their share of the mortgage payment in the case of financial difficulties. Also, a typical TIC agreement will create legal duties of each couple to the other to pay the mortgage payment, which would give the nondefaulting couple a legal claim against the defaulting couple, if it ever came to that. Of course, by the time one side is struggling so much that they can’t make their mortgage payment, they are probably what we lawyers call "judgment-proof" (meaning, so broke that they’re not worth the expense of suing).
- Get clear on risks vs. benefits a fractional loan. Once you know what you’re looking at, risk-wise, weigh the costs and benefits (and higher monthly payments!) of a fractional loan vs. the risks and advantages of a joint-and-several-liability loan. All smart real estate decision-making should be driven by your level of risk tolerance — if you and the other three can agree on a method of financing and an ownership structure that jives with your individual and collective priorities and concerns, go for it. If not, keep on house hunting, and keep the faith.
Tara-Nicholle Nelson is author of "The Savvy Woman’s Homebuying Handbook," and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Ask her a real estate question online.
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