Deed of trust split

getmore4less

spec65 said:

MWT said:

I would keep it simple:

#1 is buying 63% of the house (140,000+175,000)

#2 is buying 37% of the house (10,000+175,000)

Whenever it sells, split the net proceeds using those percentages.

My partner is having trouble understanding how this method is fair as #2 grows their money from 10,000 to 97,000 (970% increase) using the figures quoted above and #1 from 140,000 to 253,000 (81%) increase. I'm aware the percentage figures look bad and I think that's why they are struggling.

Could someone explain as to why this method is correct? Thanks! 

its not because it take the mortgage off before the split.

you split the proceeds 63%:37% then pay off 1/2 the mortgage each from your share.

The key here is servicing the debt is the same as paying cash so if you pay 1/2 the mortgage you get the equity increase from that share as well as your cash deposit.
think of 4 scenario for the £350k mortgage
1. you each put down £175k cash no mortgage
2. you borrow £175k independently (say bank of mum and dad) and pay cash
3. you borrow £175k independently (same bank of M&D but they take a charge) and pay cash
4. you borrow £175k each and combine into a single loan/charge  (a mortgage)

Financially they are all the same and you should expect the same outcome from all of them


Sometimes this simple example  works.

 if you bought a house and P1 paid 50% in cash and P2 borrowed 50% interest only.

How much of any increase should P1 and P2 get  obviously it is 50% each, 

Then P1 gets their money back and P2 pays of the debt.

different deposit and mortgage are just a variation on that where you adjust the %.

MWT

spec65 said:

My partner is having trouble understanding how this method is fair as #2 grows their money from 10,000 to 97,000 (970% increase) using the figures quoted above and #1 from 140,000 to 253,000 (81%) increase. I'm aware the percentage figures look bad and I think that's why they are struggling.

Sounds like your friend is only looking at the deposit and neglecting the fact that you have both contributed equally to a £100,000 reduction in the mortgage...

So consider it this way instead...

He purchased 28% of the house with his £140,000 deposit, you purchased 2% with your £10,000, and the percentage covered by the mortgage is 70% which you both jointly share.

So after 10 years his £140,000 is now worth £168,000 (£600,000 x 28%).

Your £10,000 is now worth £12,000 (£600,000 x 2%)

... but your equal shares of the mortgage payments have bought you a reduction from 70% to 41.6% in the amount covered by the mortgage. (£250,000 / £600,000). Thus you have each purchased a further 14.16% of the house with your mortgage payments.

14.166% of £600,000 is £85,000.

So you have £12,000 + £85,000 = £97,000

He has £168,000 + £85,000 = £253,000

What is unfair about that?

If he is expecting to see equal percentage growth based only on the respective original deposits then he would also have to pay the vast majority of the mortgage each month, and that is not the plan.

Don't disregard just how much you each have to pay over that 10 years to get a £100k reduction in the loan amount...

getmore4less

spec65 said:

Thrugelmir said:

Fair enough. The solicitor can draft up whatever you want in the declaration of trust. .

Who is paying the legal fees etc at the outset?

Legal fees are all equal. Literally everything is equal other than the deposit amounts. We know a deed can say anyhing but just wanted clarity on what was fair with the very unequal contributions to the deposit. Most people recommend just your deposits are protected and the remaining equity this split 50/50 but this fails to take into account inflation/interest on the deposits, hence situation 1. We just wanted some unbias opinions before we talk to legal to get views on the situation.

You need to include your 1/2 share of those as the starting point, that have the same values as the deposit in the purchase it is money you are putting into the pot.

Say your total costs were £10k,  £5k each,  the deposit are really £145k and £15k which for you is a significat up lift to your initial contribution.

Same with the mortgage as you are paying 50% of that you should be getting 50% of the change in value of the bit that the  mortgage bought.

if you are not owning 50:50 you should not be paying 50% of the costs of ownership.

MWT

getmore4less said:

You need to include your 1/2 share of those as the starting point, that have the same values as the deposit in the purchase it is money you are putting into the pot.

Say your total costs were £10k,  £5k each,  the deposit are really £145k and £15k which for you is a significat up lift to your initial contribution.

Same with the mortgage as you are paying 50% of that you should be getting 50% of the change in value of the bit that the  mortgage bought.

if you are not owning 50:50 you should not be paying 50% of the costs of ownership.

For simplicity I just included the other costs along with the mortgage as part of the 50/50 gain from the reduction in the mortgage, but yes it is clearly arguable that they should be added to the deposit amount instead and would have a greater impact of course.

...but if the other person in this deal is struggling with seeing beyond the deposit amounts I fear this might push them over the edge

spec65

The bank is giving you both £350,000 for a product (70% mortgage) which may increase or decrease in value. It is highly unlikely that this specific product would decrease in value over the medium to long term, however. As decreases are unlikely we are going to assume that your combined £350,000 share is going to increase in value. An example of a decrease of value will be provided regardless

At the moment in time when the bank lends you £350,000 that is what 70% of the house is worth in their eyes, of which, both parties are both equally 50% responsible. 

With a deposit of £10,000 that makes person 1 'responsible' for 37% (£175,000 from the bank + £10,000 deposit) of the £500,000 house with the above mentioned figures. 

With person 2 'responsible' for 63% (£175,000 from the bank + £140,000 deposit) of the house. 

If the product does decrease in value and you decide to sell your product (the house) you would need to pay back the bank for the product. This repayment amount would now be more than the product was originally worth so each party would have to find extra money to cover the 'gap' of what your product sells for vs what you actual owe. 

For example, the amount the bank lent you both was £350,000 and the house cost £500,000. You decide to sell the year after and you've managed to repay the bank £10,000 (£5,000 each as all mortgage and bill payments are split 50/50). The house has lost value however and is now worth £50,000 less than when it was purchased. This is a net 'gap' of £40,000 of which both parties are equally responsible. If you want to sell the house each party will have to find money to cover this gap. For party 2 this would be less of an issue than party 1. 

Formula for negative equity for each party = ((house price - mortgage left to repay) - deposit amounts)/ 2

Example with formula: 

£450,000 - £340,000 = £110,000 

(£110,000 - £150,000) / 2 = -£20,000

Person 1's deposit (£10,000) will cover half of their £20,000 loss and they will have to self fund the other £10,000 should they want to sell the house. They are currently at -£10,000, After the bank has been repaid. 

Persons 2's deposit (£140,000) will cover their entire £20,000 loss. They will leave the house with £120,000 after the bank has been repaid. 

As party 1 had a much lower deposit they are highly leveraged so their % loss would appear worse at -200%.

Party 2 had a much higher deposit so is much less leveraged so their %loss would appear to be not as bad at 14.29%. 

This outlines how the risk is actually equal to both parties, as any negative equity would have to be accounted for. The benefit to party 2 is that their deposit ensures they won't have to find money from another source. As mentioned before, this situation is highly unlikely, should you keep the house for the medium to long term.

If the product increases in value and you decide to sell your product (the house) each party would need to again pay back the bank for the product out of their own respective share (37% : 63%) of the house price sale. This split allows for each persons deposit to increase in value in line with the house price % increase in value. The difference between the two shares in the house is 26% (28% vs 2%), thus person 2s share of the house increases by 26% (50 - 13 = 37 and 50 + 13 = 63%. 

For example, the amount the bank lent you both was £350,000. You decide to sell after two year and you've repaid the mortgage £20,000 (£10,000 each as all mortgage payments are split 50/50)

The house has also increased in value by £25,000 or 5% (responsibility for the house is 37% to 63% by money input. This leaves a net increase of £45,000 of which is made up for £20,000 for mortgage repayments and £25,000 increase in house price. 

As party 1 is 'responsible' for 50% of the mortgage payment they would recieve £20,000 / 2 = £10,000 (as they paid equal contribution to the repayment of the mortgage). 

The house has increased in value by £25,000 of which person 1 is responsible for 37%. £25,000 * 0.37 = £9,250 (this figure, as discussed before, takes into account the deposit amount which is equivalent to the original deposit amount increasing by the same % as the house price increase)

The original deposit amount is also recieved back = £10,000

This gives person 1 a total of £29,250 in this situation.

As party 2 is 'responsible' for 50% of the mortgage payment they would recieve £20,000 / 2 = £10,000 (as they paid equal contribution tothe repayment of the mortgage) 

The house has increased in value by £25,000 of which person 2 is responsible for 63%. £25,000 * 0.63 = £15,750 (this figure, as discussed before, takes into account the increased deposit amount of party 2 which is equivalent to the original deposit amount increasing by the same % as the house price increase)

The original deposit amount is also recieved back = £140,000

This gives person 2 a total of £165,000 in this situation.

This calculation accounts for different despoit amounts and each parties monies will individually increase in accordance with this.

As before, party 1 had a much lower deposit they are highly leveraged so their % increase would appear better at 192.5%. 

Party 2 had a much higher deposit so is much less leveraged so their %increase would appear to be not as good at 17.85%

If the difference between the deposit amounts closed, the 'leverage' would be reduced and these figures would be closer together. 

This calculation works for any value increase as it is percentage based.

As your mortgage is a repayment mortgage rather than interest only mortgage the amount you owe for the 'product' will be constantly decreasing, regardless of the 'product' increasing or decreasing in value. As this repayment of the mortgage and subsequent decrease in amount owed to the bank will come equally from both parties 50/50, both parties stand to equally benefit from this £175,000 each (35%) 'segment' of the product.

Finally, no negative equity will be entered into provided that the 'product' (house) doesn't fall in value faster than the amount capital youre paying off from the loan amount. And over the longer term it is highly unlikely that a house would be in negative equity. 

Summary formulas: 

House price doesn't increase: 

((house value - mortgage left to repay) - combined deposit amounts)/ 2

Positive equity for each individual: 

(house value * party % share) - (mortgage amount left/2)

These formulas are different as it allows the risk of negative equity to be split 50/50 with any positive equity taking into account the respective deposits 63/37 in favour of person 2. 

Apologies for the long post but this is pretty comprehensive and explains everything for all parties I believe?. Thanks for all your help! 

MWT

To be honest, no, there is much there that doesn't make sense in the explanations and in particular with the negative equity situation you should not simply take the net loss and split it 50/50, the loss affects all the percentages and the net result would be that the mortgage consumes more of the proceeds leaving less to each party but in proportion to their relative deposit amounts and share of th4e mortgage.

So a 'small' loss like that would have a larger impact on the party with the larger deposit, in line with his larger percentage ownership of the property.

Similarly it is misleading to even talk about relating the proceeds directly to the original deposit in the case of a net gain at disposal. The only way to view the gain is by adding the total of all mortgage payments for each party to their original deposits then see how the percentage looks...

In the end though if you two are happy with what you've written then just go ahead even if it is wrong It is more important that you both agree.

MWT

Here is a worked example on the same basis as the positive equity example I provided earlier:

House value falls to £450,000 and mortgage has been reduced to £340,000.

So the relative shares of the reduced value are Party 1 £9,000, Party 2 £126,000, Mortgage £315,000.

So to repay the mortgage both parties share the shortfall (£340,000 - £315,000) so £12,500 each.

Thus Party 1 has to pay an additional £3,500 and party 2 gets back £113,500 of his original deposit.

MWT

... and a simple formula that works at any point in the future and for positive or negative equity would be...

Party #1: (70% of house value - amount required to repay mortgage) / 2 + 2% of house value

Party #2: (70% of house value - amount required to repay mortgage) / 2 + 28% of house value

spec65

MWT said:

... and a simple formula that works at any point in the future and for positive or negative equity would be...

Party #1: (70% of house value - amount required to repay mortgage) / 2 + 2% of house value

Party #2: (70% of house value - amount required to repay mortgage) / 2 + 28% of house value

This is more helpful than you can possibly imagine! Haha thank you so much. 

getmore4less

What some people forget is that you are negative on day one due to costs of a buy and a sell.
total cost to buy and  net proceeds(before paying back borrowings) can be a few £k different  before the SDLT holiday on £500k it would be £15k+  SDLT,(£10k) EA(1% £5k) + solicitors, survey, mortgage fees etc.

if paying out in cash for any of those then that effects the not borrowed deposit amounts.

If you do go down the equity % route then house maintenance and updates should be split on those %  not 50:50