Renting a house or apartment with a friend is a great way to save money, and it allows you to enjoy the company of another person while doing it. While it’s common for friends to rent a place together after high school or college, it’s often a short-term arrangement until one marries or can afford his or her own place.
However, if you don’t foresee marriage in your near future and your present roommate situation works, you might consider buying a house with your friend. While some people would never enter into a mortgage agreement with someone other than a spouse, buying with a friend can be a smart investment – as long as you know the risks.
Benefits of Buying a House With a Friend
Although others may try to talk you out of buying a home with a friend, this approach can have significant financial benefits:
1. Easier Home Loan Qualification
Anyone who has purchased a home in recent years knows the challenge of getting a mortgage loan. Lenders have tightened their standards with regards to credit scores, existing debt, and down payments. If you apply for a conventional home loan, the lender will require a minimum credit score of 680 and a 5% down payment. For this reason, many have discovered that it’s exceedingly difficult to qualify for a mortgage on their own. But with two people signing the mortgage application, the odds of approval increase.
If you decide to buy a house with a friend, the mortgage lender will base approval on your combined income and the average of both credit scores. This increases your financing opportunities, and with two people splitting the down payments and closing costs, you spend less money out-of-pocket.
2. Shared Monthly Expenses
As a property owner, it’s your responsibility to pay for utilities, maintenance, and repairs – in addition to the mortgage payment. The extra expenses that come with home ownership scare some people. However, friends who purchase together share these expenses, essentially halving the financial burden. Plus, sharing expenses improves your personal finances by giving you the opportunity to build your savings account or pay down debt.
3. Home Equity Gains
The longer you and your friend live together and make mortgage payments, the more equity you gain. Equity is the difference between your home’s value and what you owe the lender. Realistically speaking, you and your friend will one day go your separate ways, and unlike renting, home ownership lets you walk away with cash in your pocket. The two of you can split proceeds from the sale and put the money toward a down payment on your own places.
4. Mortgage Interest Deduction
When you own as opposed to rent, you pay interest on the mortgage, and that interest is deductible on your taxes. The higher your income, the more benefit you’ll see from this deduction. However, if you own a house with a friend, the amount of interest you each deduct must add up to the total interest paid on the loan that year, and no more.
For example, let’s say you jointly own the property and together paid a total of $14,000 in mortgage interest. One of you can deduct $14,000 on your tax return (while the other deducts nothing), or you can split the mortgage deduction 50/50 (or in any other way you deem fit). How much interest you can deduct may also depend on the type of ownership you have. But as long as you work out or understand what percentage of the mortgage interest you can each deduct, owning a home can be a big boon come tax time.
Downsides of Buying a House With a Friend
Despite certain advantages, there are a number of problems that can arise if you buy a house with a friend:
1. Difficulty Moving
In a perfect world, you and the other owner will always get along – but, of course, disagreements are bound to occur. Problems can arise between roommates, and unfortunately, some joint owners are unable to work out their differences. When you rent an apartment with a roommate, it’s easier to walk away. However, it’s not so simple when you own a house.
Both of your names appear on the mortgage, and therefore, you’re both responsible for the home loan. If the other owner becomes upset or decides to leave, he or she can’t just pack up and move out. To break all ties, you have to either sell the house, or refinance in one owner’s name. Neither option is simple – it can take several months to sell a house, and if you can’t qualify for the mortgage on your own, a lender will not refinance, and the other owner’s name will be stuck on the mortgage.
2. Potential Credit Score Damage
You might be responsible and pay your half of the mortgage payment and utilities each month. Unfortunately, your roommate might not be. Your friend may initially pay on time, and likely has the best of intentions. But a job loss or huge medical bills can strike anyone at any time. And if your roommate is unprepared and can’t pay his or her share of the mortgage, it could affect your credit rating. Since both names are on the mortgage, you’re both responsible for payment, and the bank will report you as well as your roommate to credit agencies for non-payment or in the case of foreclosure.
3. Difficulty Qualifying for Other Loans
A big loan on your credit report may limit your availability to qualify for other loans, such as an auto loan. In seeing whether you qualify, the lending institution will look at the amount of debt you’re responsible to pay monthly relative to your income. Since you’re responsible for the entire mortgage payment (your friend is also), your debt to income ratio may increase such that you can’t qualify. Spouses often deal with this issue by both applying for other loans together. However, you may not want your roommate on your auto or any other loan (and he or she may not want that either).
Buying a house with a friend can work well, and be beneficial for all involved. However, don’t rush the decision. Do what the banks do – check each other’s credit report, income, and assets to get a better sense of how likely a potential roommate is to make timely payments as well as his or her ability to make payments if income is temporarily lost. Additionally, hire an attorney to create a cohabitation agreement which outlines important details, such as the type of ownership (joint or tenants in common, for example) and how you’ll pay for ongoing expenses, such as repairs and insurance. Plus, it’s a good idea to take out a term life insurance policy on each other – enough to cover the mortgage in the event that one owner dies.