The median age of first-time homebuyers hit a record high of 40 last year, according to data from the National Association of Realtors. Low inventory and rising prices have pushed homeownership out of reach for many.
To make housing more affordable, some people are embracing a nontraditional path to owning a home: co-buying with a friend.
“This is a new and interesting way to get into real estate,” says Brett Humphrey, CEO of Joynt, a platform that helps people buy and manage property together. “I firmly believe this is a viable way to get into the housing market.”
Six in 10 renters say they are open to the idea of purchasing a home with a friend, according to a survey of nearly 2,000 renters conducted by Rocket Mortgage. Of those, 64% say affordability is what drives them to consider this route. About two-thirds of those who would buy a home with a friend are from the Gen X and millennial generations, perhaps signaling that middle-aged Americans are tired of waiting for the time when they can afford a house on their own.
“There are a lot of pros to buying a house with a friend,” says Brian Boruszak, senior home lending advisor with Chase Home Lending. “The biggest one is that it might increase your borrowing opportunities.” With income and assets from two people, borrowers may qualify for a larger mortgage, which expands their housing options.
Here’s what you should know if you want to buy a house with a friend:
— You should fully disclose all your finances first.
— It’s smart to rent together before buying together.
— There should be a written agreement for shared expenses, taxes and house rules.
— Having an exit strategy in place before making the purchase is essential.
— Both applicants’ financial information will be reviewed.
— You can buy a house as an LLC, although mortgage options may be limited.
Fully Disclose Your Finances
Purchasing a house with a friend is no small decision. It will have a major impact on both your finances and lifestyle.
“It should be clearly transparent on the way in,” says Scott Lindner, national sales director with TD Bank Mortgage, which offers loans to homebuyers in 16 East Coast states.
He recommends each person meet separately with a mortgage lender to review their financial position and learn how much they can afford to contribute to the purchase. “They should know who has the ability to pay,” Lindner says.
Then, you and your potential co-buyer should sit down and talk about your incomes, assets and financial expectations for the purchase and maintenance of a home.
“At the very least, get a credit report for each other,” advises David Silversmith, senior tax manager with accounting and advisory firm EisnerAmper.
That will provide a window into how you both manage your money. If someone’s report is riddled with late payments and defaulted accounts, you should think twice about partnering with them on a home purchase.
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Rent Together Before Buying Together
Money is only one consideration in co-buying a house. The other is whether you and your friend can live harmoniously.
“Live together in a rental property first to see about compatibility,” Lindner suggests.
A year in a rental apartment or house will provide the insight you need to know whether you and your friend will be able to live together successfully in the long term. If you discover your habits are incompatible, it will be easier to go your separate ways than if you bought a house together.
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Have a Written Agreement for Shared Expenses, Taxes and House Rules
Ruined relationships and lost money are people’s two biggest fears about co-buying, according to Humphrey. Having a written plan can help guard against both of those outcomes.
“No one should go into this without devising a plan,” Boruszak says.
For instance, what happens if someone dies, Silversmith asks. Does the house go to the other person or is it inherited by heirs? You’ll also want to discuss how home maintenance and repairs will be paid, as well as how mortgage-related tax deductions will be split.
“Have it written that all expenses have to be 50/50,” Silversmith suggests.
A co-ownership agreement should also spell out house rules that address the following, among other things:
— Pets
— Smoking
— Guests
— Chores
— Quiet hours
— Rental policies
You should also determine how decisions will be made in the future and how disputes between co-owners will be resolved.
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Create an Exit Strategy Before Making the Purchase
“The other part of the up-front planning is creating the exit strategy,” according to Lindner. He says people need to “Figure out the exit strategy well before they are going to need it.”
That starts by getting on the same page about the long-term plan for the property. Problems can arise when one person thinks of co-owning a house as a long-term arrangement, while their friend expects it to be a short-term situation until they are married or have kids.
Even the best laid plans can change, so you need to know what happens when one person wants out of the co-ownership agreement.
“A refinance would be the easiest option,” according to Boruszak. It would likely need to be a cash-out refinance to pay the departing person their portion of the property’s equity.
The refinanced mortgage could be larger than the original mortgage, depending on the property’s appreciation. If the remaining owner can’t qualify for a loan on their own, the lender will refuse to refinance. That means that even if someone leaves the co-buying arrangement, they could still be listed on the mortgage and legally liable for its payment.
Co-buyers should consider this scenario as part of their pre-purchase planning. If someone can’t refinance the property to own it outright, selling may be the only other option.
Prepare Both Applicants’ Financial Information For Review
Once you have rented together, drafted your co-ownership agreement and settled on an exit strategy, it’s time to buy a house.
“They process itself isn’t too different from a mortgage standpoint,” Boruszak says. “They could both be on the mortgage if both are needed to qualify.”
A lender will want to review employment, financial and credit information from both applicants. If one borrower has a poor credit history, that could affect the loan approval and mortgage rate.
Consider Buying a House as an LLC, Although Mortgage Options May Be Limited
There is an alternative to co-buying a house in your and your friend’s names.
“I always beg people to buy the house in the name of an LLC,” Silversmith says. “It’s so much easier that way to get your name off an LLC.”
With an LLC, one partner can buy out the other person’s share without having to refinance the property. It can also make it easier to add another co-borrower or convert the home to a rental property. Creating an LLC may sound intimidating, but using an online service such as LegalZoom or Joynt can make it simple and inexpensive.
The problem with LLCs is that they are not eligible for Fannie Mae- or Freddie Mac-backed conventional loans. You’ll need a nonqualified mortgage instead. Another option may be to apply for the mortgage as co-borrowers and use the LLC for the title.
“We recommend getting a conventional loan and then title it to an LLC on close,” Humphrey says.
Not all lenders are willing to do this, though. Before going this route, talk to your mortgage lender to learn if and how they handle LLC home purchases.
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Co-Buying a House with Friends: How Mortgages and Ownership Work originally appeared on usnews.com