Q: My friend and I have been close for 17 of our 23 years, and we are quickly tired of throwing away money by renting apartments. Between the two of us, we gross about $40,000 a year, and we can raise a down payment of between $5,000 and $8,000. We are interested in buying a two-bedroom residence. We have little collateral, but excellent credit ratings. It is probable that both of us could get relatives to back up a mortgage for us should it become necessary. We both will be in the area for at least two more years, but might be leaving afterward. Will we be substantially better off if we formed this joint venture rather than renting for the next year? Do you foresee any difficulties between two friends? A: I think you both are wise to consider home ownership at this early stage in your life. If you are already making good money now, I suspect that both of you will be quite successful in the years to come -- and you will be glad that you had the foresight now to invest in real estate. In my opinion, while real estate is not appreciating as rapidly as it was doing in the 1960s and 1970s, it still is a good, safe long-term investment.
Obviously, this is a general statement. You have to consider many issues when deciding what kind of real estate to buy, including such questions as location, the cost of future maintenance and repair, and the age and condition of the property.
You have indicated that you may be leaving the area in a couple of years. I strongly recommend that you consider obtaining an adjustable-rate mortgage on a program whereby the rate will adjust every year. Today, such ARMs can be obtained at an initial rate of less than 10 percent. This ARM should have an annual cap of no more than 2 percent and a lifetime cap of no more than 5 percent. Thus, even if you keep the house for three years -- and in the worst scenario where the interest rate goes to the maximum -- at the end of the first year your rate will be less than 12 percent and at the end of the second year your rate will be less than 14 percent, leaving you with an overall three-year average of less than 12 percent. That compares quite favorably to fixed 30-year loans, which also are obtainable today.
There are clear tax benefits if you buy, rather than rent, your house. The interest and real estate taxes that you pay are deductible, and presumably any points that you pay to obtain your mortgage loan also will be deductible. I use the word "presumably" because the points have to be structured so that you are eligible to take the deduction. Try to have the lender send your title lawyer a gross check, so that you will pay the points separately at settlement. There is a tax court decision indicating that points deducted from the lenders' check (i.e., a net check) may not be deductible.
I suspect that, between your two incomes, you probably can afford a house in the price range of between $75,000 and $80,000. You may want to consider entering into a shared-equity arrangement with one of your relatives, and this might enable you to purchase a more expensive piece of property. Space is limited in this column to discuss shared equity, but it should be explored, because it may provide additional tax benefits for your relatives, while at the same time enabling you to buy a more expensive house.
There is one note of caution, however. You have indicated that you have been good friends for most of your life. I suggest that you try to preserve your friendship by putting the entire agreement between the two of you in a written document, signed by both of you. I have found that one of the best ways to break up a friendship is to become a partner with a friend. I am not trying to discourage the joint venture, but the time to enter into the written partnership agreement is while you are still talking to each other. This document should spell out items such as: #F* Who will pay what items and what amounts.
* Who will be responsible for repairs and maintenance.
* Buy-out rights if one of you decides to leave.
* An agreement to arbitrate any disputes that may rise, rather than having to take your friend to court.
The existence of a written partnership agreement cannot be stressed too strongly.
In my opinion, to obtain the maximum tax benefits and to preserve the favorable interest rates currently available, act quickly in setting up your joint venture.