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Working out % share of house - tenants in common
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This will probably be my longest ever post and I am not usually short of words as it isThe deposit put down initially should be a % of the price the property was bought at.
When selling, each person should then get this % of the sold price back, then any other equity should be split 50/50.
For the OP it's fine but for the flatmate it would be a poor deal in a sea of options. There are loads of variations, which can have very different results.
I agreed a deed of trust when buying with friends and had similar dilemma. In the end we funded all the deposit equally and intend to split the mortgage payment equally, but if someone fails to pay their share of the repayments you need a documented mechanism for dealing with uneven funding anyway.
I won't comment on the potential stresses on friendship and what happens if someone dies, or becomes unemployed, or wants to sell and the other doesn't, or wants to redo the kitchen or double glazing or to move out or move a spouse or unexpected child in - presumably you have dealt with all that. And who gets the best bedroom? Anyway - to the finances!
Method One - "Loan finance" method
The friend has put in 10k more than you and you decide to treat it effectively as if this were a loan. After all, he could have been saving it in his own bank account or another investment scheme but has decided to use it in a way that reduces the level of mortgage loan. The loan has been made 'to the house' rather than specifically from him to you, and it benefits both of you in terms of lower mortgage borrowings.
This additional voluntary amount of 10k which he wants to recover out of the first slice of net sale proceeds (i.e. after clearing mortgage but before paying you or him your other 10ks) should increase with interest each year at at least the same rate as your mortgage. The loan is not as 'safe', to him as lender, as the real mortgage is from the bank's perspective, because bank gets paid first. And also the very fact he put this extra 10k in will possibly have reduced your LTV and you might be on 3.75% with the bank instead of 4.25% without it. So agree a fair rate of interest for him, negotiated between the two of you. Perhaps [the mortgage rate] plus 0.5% or more.
So lets say you sell the house after five years and your rate was 5% and his compound priority return should be 12760 (1.05x 1.05 x 1.05 x 1.05x 10.5 x 10k). If there is 40k of net proceeds after mortgage, he gets allocated the first 12760 then everything else is split 50/50 on the basis that the rest of the deposit and mortgage principal repayments were funded 50/50. So you get 13620 and he gets 13620 + 12760.
Effectively he earned a fixed interest rate on his first 10k, while the 13620 you each got is the equity return on your 10k initial deposit and whatever mortgage principal you paid down with your monthly payments. Overall the 13620 is bigger than the 10,000 you put in on day one but it might represent a profit or a loss on those total payments depending on the size of your monthly principal repayments.
This all sounds straighforward but it is perfectly possible that by the end of it, particularly if you don't hold the property for very long, you are not in a profit situation. It might not be possible to guarantee he gets back every penny of deposit plus interest because the mortgage man has to come first. So his priority return is really a 'preferred' return rather than a guaranteed one. There are a couple of obvious ways to deal with this and neither is 'unfair' but the risks will be different.
i) if you only have 13k cash to distribute at the end, and his priority amount plus interest is 12760, then he would get 12760 plus 120 and you would just get 120. If there was 12.5k he would get it all and you get nothing. In this way he really has been protected as best you can. Or:
ii) if you only have 13k you look at the total deposit contributions (his 10,000 plus 12760, and yours 10,000) and you split the cash in the ratio 22,760:10,000 resulting in him getting 69.5% of the proceeds where he had only paid 66.6667% on day one. So he's been given a bit of a reward to say thanks for the extra deposit but he's still lost a bigger sum than you. So he's not been protected as well as he could have been, and if he was taking more risk without having a good chunk of extra profits in the good times he would be unlikely to think that 4.5 or 5% was a fair rate for the risk.
Ultimately you can negotiate interest rates and what happens on the downside, one assumes that he doesn't want to give you a free ride but also he knows it would be harder for him to get a place on his own with 20k rather than getting a place for two with 30k and shared bills and maintenance.
This 'loan' method of giving one person a priority return out of the house equity on a sale, would seem to be more effective than drawing up a separate 5k loan between the two parties as some people suggested. From the flatmate's perspective it is more secure and tied into the house ownership documentation, and also if one lends the other 5k the interest income received will be subject to tax - whereas we are simply carving up sale proceeds and the interest is just a notional concept. Disclaimer I am not a tax advisor or lawyer so this might be nonsense.
Method Two (if you are still awake, well done) - "Equity" method
Track the total payments of deposit plus monthly mortgage principal being made, with the intention of splitting all house proceeds on this basis.
Example in year one you might pay your deposit and each make 5,000 of mortgage payments of which 3,500 was interest and 1,500 was principal. So on a 130k house, you have made 11,500 of real contributions into the equity of the house and he has made 21500 and the mortgage balance which started at 100,000 is now 97,000.
If you sell the house for 163k after paying the mortgage there is 66k of cash remaining, and this cash gets split on an 11500:21500 ratio so you get 23k and he gets 43k. You both double your money.
If the house loses money and you sell for 113.5k, you use the same ratio to split the 16.5k cash, you get 5750 and he gets 10750. You both halved your money.
There are a number of issues with this simple equity method. There is the time value of money - should the day one payment only get the same 'weight' as the mortgage payment in month 12? Should we really disregard the interest element of the mortgage payment - the flatmate is physically paying it even though he made an extra effort to reduce the mortgage balance on day one with an extra 10k contrbution and you did not? But if we include the interest element we are counting larger total monthly payments - and this is to your advantage, because the extra 10k he paid will become relatively less valuable when you have both paid down 20k of principal and 50k of interest?
It would seem like you could fix some of this by adding a 'time value of money' to the periodic payments so you just have a notional interest rate on the day one contributions and the month two contributions and the month three contributions etc. Then you are on a fairer footing when using those contributions plus interest as the basis for a split on sale.
It will take you a long time to catch up your relative proportions if you are only paying equal amounts, so if your mortgage co allows overpayments, perhaps you can make overpayments and him not, allowing you to close the gap within three years or so until you have knocked the mortgage principal down to where it would be if you had also put in 20k on day one. Meanwhile how do you fund a new boiler or other '!mprovements' beyond day-to-day maintenance? Presumably 50:50 or perhaps you pay more if you can, and be credited for that to help equalize your stake.
Conclusion ?
There are many ways to do this. This is a geared investment with presumably a large mortgage so if it goes up by 25% over the next five years you will more than double your money. If it doubles you might be looking at a 6x return on equity. Having him put in only 10k more on day one and then equally fund everything, you are going to be jealous when the 'larger equity stake' method means he walks away with 60k cash more than you. And in contrast if markets move the other way he is going to be annoyed if he helps you out by throwing 10k extra into the pot and loses more than you on a sale.
For this reason, although having unequal equity portions can be perfectly workable, I would suggest his extra contribution doesn't just go as simple equity but as some sort of protected deposit / interest bearing amount - and probably at a rate which is a bit higher than the mortgage interest charged by the bank. So something like my first method. outlined above.
But as the pros and cons are different for you and for him (he wants to get the most out of his payment and you want him to get the least), you are going to need to sit down with some figures and work out what you want and how to make a case for it being a fair solution.
There's no right answer other than what fits your personal circumstances. There are only ideas. That's why I threw some figures in above because you have to know the upside and downside for both. When you get your spreadsheets out, look at the sensitivity to different sale prices, what you think of the likelihood of the different sale prices happening in different timescales, and the likely size of the monthly repayments (especially if your mortgage deal isn't fixed rates).
And if you can't agree, that doesn't bode well for becoming cohabiting business partners who have put their life savings into a deal together and are jointly liable to a bank for an amount bigger than their combined salaries.
Good luck:beer:0 -
As has been said all fair ways end up as one of two basic methods
LOAN:
The larger deposit lends the smaller 1/2 the differnece and you just do everything 50:50 as thats the equity owned. Have a side agreement for the loan.
EQUITY. you buy equity.
your deposit buys a % of the property and paying part of the mortgage buys another % you can either have equal shares so smaller deposits pay more of the mortgage or you split equity not on a 50:50 basis
you don't have to track anything as long as you keep paying the mortgage in the % that have been calculated it just works.
eg £20k + £10 £180k mortgage
50:50(£105k each) the smaller deposit pays 95/180 of the mortgage the larger 85/180
(you split the sale 50:50 and pay of the mortgage in the same ratio)
or you pay the mortgage 50:50 and own 100/210 110/1210.
(on sale you split the proceeds at the % and each pay off 50% of the mortgage)
These work for all value of deposit and mortgage payments.
All capital improvements.maintenance is done at the equity %.0 -
Some find it difficult to grasp the it just works for mortgage payments but it does.
As long as you keep the % of the mortgage you pay the same even for interest only repayment and overpayment is just works. the amount you owe stays at that %,, you don't need to track anything.
If one person has more capital to pay off the mortgage at some point you can readadjust the mortgage payments without changing the actual equity owed very easily.
Once you get it right it becomes very simple to mange the debt and equity.
The othe key as has been pointed out is you need a good well though through exit plan that includes death.
It is really important to remember that converting debt and equity requires valuation(so difficult except when buying and selling) so it best to keep the equity fixed from day one and deal with the debt seperately.0 -
If you're paying the mortgage 50:50 then why don't you agree that upon sale he takes £20k, you take £10k, then split the rest down the middle?First Time Buyer: Mortgage Offered, Searches complete, Exchanged 21/12/2012, Completion 04/01/2013! :beer:0
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julieb1987 wrote: »If you're paying the mortgage 50:50 then why don't you agree that upon sale he takes £20k, you take £10k, then split the rest down the middle?
That is the higher deposit lending the lower one £5k interest free.
Problem is it does not reflect the relative risks and favours the higher deposit on price drops and the lower deposit on price rises.0
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