With rising interest rates and housing prices a concern for homebuyers, many are looking for creative ways to fund home purchases. An unconventional yet practical option of purchasing a home is with a trusted friend. Partnering with your friend to handle the mortgage costs isn’t much different than sharing the costs of renting a home together, but it does raise some legal and financial concerns that renting wouldn’t. Read on to learn what you need to know, including the risks and the financial implications.
What Happens if One of You Makes More – or Less – Money?
One of the first considerations to make before entering this agreement is income. If you and your friend (aka co-borrower) have very different income levels, you may need to split the costs of the home accordingly. Perhaps one person will pay the majority of the mortgage, while the other pays the majority of the household utility costs. Or maybe you’ll split the expenses by a percentage. Regardless of what you decide, do consider incomes when making this choice, and then have a written, legally-binding agreement in place to ensure you both stick with this decision.
What Are the Pros?
1. Larger Down Payment
If you combine your savings, you may be able to afford a larger down payment. This, in turn, could help you get terms that are more favorable and a lower monthly payment. Plus, if you’re able to put down 20% of the home, you’ll avoid Private Mortgage Insurance (PMI), which will save you even more.
2. Improved Credit
Having more than one borrower can improve your overall creditworthiness. For example, if you have a less than perfect credit score, having a co-borrower who has a more solid credit history will make you, collectively, look like a better option to your lender. This could help you secure a lower interest rate. Of course, the opposite is true, too. If your friend (or you) has a low credit rating, you may qualify for a loan, but at a higher interest rate.
Fun fact: Owning a home and making timely monthly payments can also boost your score. So if you do buy with a friend, but plan to buy another home in the future, you will be in an even better position the second time around!
3. Gains in Home Equity
If you and your friend decide to move away from your shared home, you’ll likely build some equity in the property. You’ll split that equity based on your initial agreement, and that could give you the money you need for your next home purchase down payment (keep in mind this may require one party to sell to the other if they move – which likely requires a mortgage refinance – more on this later).
4. Tax Deductions
Mortgage interest may be a tax-deductible expense, and when you share your home loan with someone, you can split that tax deduction right down the middle. This allows both of you to receive a tax break. For example, if the total interest paid on the mortgage for the year is $10K, you and a co-borrower could each reduce your taxable income by $5K when filing your taxes. Keep in mind there are different ways to file taxes – standard vs. itemized deductions – so it’s recommended to speak with a tax professional for specific information regarding your individual situation.
What Are the Cons?
1. Hard to Make Changes
If you rent, you simply need to finish your lease term and you can leave the home. When you own a home, walking away means you either have to sell, or you have to work with your friend to refinance the loan to get your name off of the mortgage. Both cost money and take a considerable amount time – plus, all parties have to agree.
2. Credit Risks
While mutual borrowers can look less risky to lenders because of their shared credit, you are relying on another person to keep up their end of the bargain. If they do not pay their portion, you either have to pay it yourself, or you could face an eventual foreclosure by the lender. A foreclosure will negatively affect your credit rating, even if you were not the at-fault party.
3. Jobs Could Change
When you enter a mortgage agreement with your friend, you know both of your incomes at that time. However, nothing is guaranteed and your friend’s income may change. This could make it harder for them to pay their portion of the mortgage and other expenses, which can put you at risk. You have to rely on job security not just for yourself, but also for your friend.
4. Renovations Get Complicated
When you share a space with another person, you may find it is more difficult to make renovations when and how you would like them. Your roommate and co-borrower may have very different ideas about what is the best use of your space, what is a fair financial investment (do you split everything equally?), and what is not.
Considerations About Sharing a Space
As you decide whether or not co-owning a home would work for you, consider the ramifications of sharing a space. Will your friend want to have guests over? How will you establish privacy? Are there families involved that need separate spaces? How will you relegate kitchen cleaning duties? All of these questions should be answered before you start shopping for a home. It might even help to add these to your written agreement.
What Happens When You Sell?
When you sell the home, you will both have to agree to the sale. If one person wants to sell and the other does not, one co-borrower cannot force the other to sell. Instead, the co-owner who wants to sell can sell his or her interest in the home to someone else. If one borrower is staying in the home, regardless of who buys out the other borrower's interest, the home will need to be refinanced and the names changed on the loan and the deed.
Protect Yourself – Use an Attorney
These agreements can be beneficial for both borrowers, but they have many potential pitfalls. To protect yourself, make sure both you and your co-borrower use an attorney (Tip: you may want to use separate attorneys, to ensure no party feels like there is favoritism towards one party). You need a cohabitation agreement that is legally binding, outlines the sharing of expenses and even creates an exit strategy if and when someone is ready to move. This will protect both of you and limit any confusion or disagreements.
Tips for Success
If buying a home with a friend seems like the best way you can afford a house in the current market, consider these tips for success:
- Know your co-borrower well and understand their financial situation and credit history.
- Create legal documents with an attorney prior to entering the agreement or financing the mortgage.
- Buy less house than you can afford to safeguard against job losses or unexpected expenses.
- Set rules for cleaning, guests, pets and anything else that could cause a future disagreement.
- Put both names on the mortgage and the deed.
- Secure your investment by purchasing life insurance for each co-owner. This will ensure each individual has enough coverage to cover his or her portion of the outstanding mortgage. For added peace of mind, list your co-borrower as a beneficiary on your policy.
Ready to Buy or Have Questions? We’re Here to Help!
If you’re ready to buy a home – whether on your own or with a co-borrower – HVCU can help. Reach out to one of our mortgage experts today to learn more about your home financing options, and to see how you can get started on your path to home ownership.