Buying a cottage or a rental investment property in Muskoka can be a smart financial move. As you pay down the debt, you build equity in a property that will in all likelihood appreciate in value over time.
There are the tax benefits in most cases as you can deduct your rental expenses from any income you earn, including items such as mortgage interest, property taxes, insurance, repair and maintenance costs, and property management, all of which saves you money at tax time. The primary benefit of course is the revenue stream it will generate. However, as owning investment property requires an investment of time and effort as well as money, choosing to share that burden with a friend can make sense. This is definitely appealing but it will come will with some challenges. Here are five things to give serious consideration to before investing in real estate with a friend.
1. Your Mortgage Rate Will be Tied to Both Credit Reports
When applying for financing on a property purchase both you and your friend’s credit history will be used. If one of you has bad credit it can negatively affect the mortgage terms, including the interest rate that you pay on the loan. Remember that even a minor change in interest of even 0.5% will make a big difference in the amount due every month on your mortgage and in the total interest you’ll pay over the life of the loan.
2. You Risk Your Good Credit Rating
When both you and your friend are listed on the mortgage, you are both responsible for making payments. If the mortgage falls behind for whatever reason, the lender will report both of you to the credit agencies for non-payment even if it is not you personally in default. Because both names are on the mortgage, your friend’s non-payment could end up costing you big on your credit report and significantly affect your future potential to borrow money for your personal requirements.
3. You May Have Challenges Getting Other Loans
Assuming there are no issues and you and your friend split the mortgage payment each month 50-50 with no defaults you still need to know that each of you alone is responsible for the entire mortgage payment. To a new lender, say, for a car loan or a personal home purchase, this can have a substantial impact. They will include the whole payment amount of that mortgage in the debt-to-income ratio calculation and it may make it difficult to qualify for other loans.
4. No “Easy Button” for Moving Out
If you rent an apartment or house with a friend, it’s usually easy to walk away if the two of you no longer get along, or if you just decide to move. Not so with a mortgage. Since both of your names are on the title of the property and the mortgage, you are both responsible for making the payments. To get one of the names off the mortgage and deed, you have to sell the house on the open marker or one to another. Selling on the open market can take time and sometimes even result in a loss if the market conditions are not ideal.
It’s a good idea to have a written agreement in place that details your agreed-upon exit plan should one of you decide to move on. The agreement should also cover what happens if either of you dies. Does the survivor become the sole owner, or does he or she need to buy out the heirs of the deceased partner? What percentage of the property you each own? Will the property be sold, and if so, how will the proceeds be divided?
Another good idea for financial protection is for both parties to purchase life insurance on the mortgage in case of death.
5. Disagreement Over Responsibilities
A great friendship can be quickly tested if there are any disagreements over who is responsible for a property related undertaking. Payment of utilities and taxes, maintenance, hiring support help when required, budgets for work required and other items that need attending to in a timely fashion are all potential sources of conflict. To avoid this, include in your written agreement details regarding the breakdown of expenses, how repairs and maintenance will be handled (who will do the work, and how the costs will be shared), plus how deductions will be claimed (e.g., who gets to claim the mortgage interest deduction or whether you split it in some way).
The Bottom Line
Buying an investment property with a friend will have lots of benefits:
- It should be easier to qualify for a mortgage
- you get to share all the monthly expenses, including utilities, maintenance/repair costs and the mortgage payment.
- you get to build equity as you pay down the loan.
This kind of purchase will also have some challenges and it is important to make a well thought-out and informed decision. Do your homework ahead of time, and make sure you and your friend both have the income to meet the monthly expenses of the investment without relying on any potential income from it.
Most importantly, protect your friendship and avoid trouble down the road by having a written agreement. It is a good idea to hire a lawyer to write a comprehensive agreement that details who is responsible for what, what happens if one of you wants to move on, and how the property will be handled if one of you passes away.
If you and a friend have been pondering this type of partnership I would be delighted to help you find the perfect property, call or email me today!