Buying a House with a Buddy? Get a Pre-Mortgage Agreement

James R. DeBoth, President
Interest.com

You've probably heard about "pre-nuptial agreements," the contracts some people sign before getting married that spell out what happens if—and far too often when—the marriage falls apart. While few of us are in the sort of tax bracket that would make a pre-nuptial agreement necessary, if you plan to buy a house with someone other than a spouse, you might want to consider a pre-mortgage agreementt.

"When two people buy a house they are entering into a partnership. In many respects it has to be looked at like a marriage," explains William Slocumb, a Bakersfield, California attorney who does a great deal of real estate work. When friends buy a house together, which is often referred to as "buddy buying," their lack of any romantic connection doesn't change the fact that their relationship really is a lot like a marriage. "It's fine as long as the two people get along and agree on things. But if they get sideways with each other, there can be real problems." Before looking at the how to deal with the results of what Slocumb calls "getting sideways," let's look at what's actually involved in buying a house with a friend, and why people do it.

Lenders don't really care if you're married, related, or just friends with the person with whom you are buying a house. They are concerned only about the actual value of the house being bought, the amount of the loan and the down payment, and the debts, credit histories, job stability, and incomes of all of the people whose names will appear on the loan. While it might be possible to think warm-and-fuzzy romantic thoughts about a house, it's hard to do the same thing about a mortgage. The lender's focus is on the business--on profits, losses and costs.

Those are usually the same reasons that people buy houses together. It's a good investment. They have weighed the potential profits, looked at the costs and possible losses, and decided it beats renting. Since many single people cannot afford to buy a house on their own—especially young singles who are doing most of the "buddy buying" today—they have to find someone with whom they can buy and share a house. And while there really is no truth to the old adage that "two can live as cheaply as one," it is true that two together can almost always live more cheaply than two apart.

The real question, however, is not can they live cheaply? It's, can they live amicably? And if they don't, what happens? Are both partners "equal" owners? Or is one of them "more equal" than the other? Does one partner consider himself or herself more equal than the other? Or as Slocumb put is: "Who's in control?" For that matter, what happens if one of the partners dies? Who inherits the other half of the house? That last question is the easiest one to answer. It all depends on how they bought the house. Let's say Chris and Pat were roommates in college, and they decide to buy a house together. Then Chris dies. If they bought it as tenants in common, then Chris's heirs, or next of kin, inherit the house, and Pat has a new mortgage partner, and possibly a new roommate. "If they bought it as a joint tenancy, which is how most married couples buy a house, then if one dies the other owns the whole thing. So you want to plan for what happens if one of you dies." If the house was bought as a limited liability corporation, or as a partnership, then these types of questions need to be covered in the contract.

While the question of "Who inherits?" is easy to answer, the question of "Who's in charge?" is not. If they merely signed a contract showing that they are both "equal" partners, then, from a legal standpoint, neither is more equal than the other. Legally speaking, neither is in control. With that established, what does one partner do if the other partner wants out of the deal? What if there are arguments about renovating the property, or even paying the bills, or renting that spare room? What if one partner fails to pay a bill and the one who is owed the money slaps a lien on the house? What if one partner wants to sell?

Let's look at Chris and Pat again. Their house is worth $100,000. Chris wants to sell, but Pat doesn't. Even though the house is worth $100,000, no one will pay Chris $50,000 because they are buying a partial interest in it, and getting a roommate. The best Chris might get on the street is $40,000, and might have to settle for less. Of course Pat knows that Chris can sell to anyone, and that whoever buys can move in. Chris could ask Pat to buy the "other half" of the house for $50,000, but Pat could decide to offer Chris that same $40,000, or less.

When things go wrong, you can always sue, but that is both time consuming and expensive. It's a lot better to have a contract in place that deals with any problems that might arise. What happens, for instance, if one partner goes bankrupt, or just stops paying, or leaves town, or disappears? These are all questions to discuss with a lawyer before signing either the pre-mortgage agreement, or the mortgage.

Slocumb says that one of the most important issues that the contract needs to address is how to get out of the deal when one partner wants to sell and the other doesn't. The first thing the contract needs to do is spell out how the value of the house will be determined. "It could say that each partner hires an appraiser," Slocumb suggests, "and the two appraisers bring in a third one, and they decide on a value." The contract could also stipulate that unless one partner is willing or able to buy the other one out at half of that agreed upon price, the entire house must be sold and the proceeds split.

There are a lot of reasons for good friends to buy homes together. They save money on rent, reduce their taxes, and build equity. They also get to spend a lot of time together. There are even better reasons to make sure they have a contract spelling out exactly what to do if their friendship turns sour.

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