Before buying a vacation home with your golf buddy, bridge partner or old college roommate, work out all the details, such as how to finance the purchase, divide expenses and schedule getaway time slots.
Most important, decide what happens if one party wants out. Failing to negotiate these issues ahead of time can lead to disputes that can turn friends into enemies.
To head off trouble, attorney Ethan Miller drafted an “equity-share agreement” for the vacation house in Dorrington, Calif., that he purchased for $510,000 with his longtime friend in 2006.
Even though the two friends—and later, their families—had vacationed together every summer for 30 years, he wanted to ensure there would be no conflicts. Their agreement spells out monthly and annual expenses, such as property taxes, insurance, utility bills and repairs. Each year the friends estimate the annual costs and write a check to cover them. An end-of-year reconciliation enables them to settle any final expenses, as well as estimate costs for the following year.
The equity-share agreement also details what happens if one person no longer wants the property, giving the other person a way to terminate the arrangement and either sell the house or buy out the other party’s share at fair market value.“An equity-share agreement sets an expectation level that pre-empts disagreements,” says Mr. Miller, a trial lawyer with Hogan Lovells US. “Regardless of how close you are, things could change.”
To purchase a vacation home, buyers often use cash reserves or tap equity from their primary residence. According to the National Association of Realtors, 38% of vacation-home buyers paid cash in 2015, up from 30% in 2014. Paying cash certainly simplifies the transaction.
Buyers who plan to finance their purchase should be prepared to put at least 20% down for a jumbo loan—with amounts above $417,000 in most parts of the country and $625,500 in high-priced areas—says Bill Banfield, a vice president of Quicken Loans in Detroit. Buyers typically apply jointly, and both need to qualify based on their total income and debts. The qualification is based on the borrower who is least creditworthy, so a friend with a poor credit history could affect your ability to get a loan.
Vacation homes are typically purchased with the title held by a limited-liability company, or LLC, a hybrid legal structure that offers members the limited liability of a corporation with the tax advantages and flexibility of a partnership. Alternately, ownership can be structured as a tenancy in common, where two or more people hold title without the right of survivorship. Either way, John Voltaggio, a managing director of the Wealth Management Group of Northern Trust in New York, advises buyers to also have an operating contract—a sort of prenuptial agreement that governs the use and maintenance of the property.
Even if buyers plan to use an LLC to hold the title, they will most likely need to apply and qualify for a loan as individuals, says Mr. Banfield. If one owner fails to pay his fair share, the other could be responsible for paying 100% of the loan.
“In rare cases, custom financing may be available where people will use a personal guarantee with an LLC,” he said. “But traditionally, the vast majority of lenders will only qualify the buyers as individuals on the loan.” That’s because an LLC set up solely to hold title to a vacation home will usually have no other assets or income.
Here are a few things to consider before you buy a vacation home with friends or relatives:
• Keep emotion out of it. Think of your purchase as a business deal. Negotiate all aspects of ownership—usage and expenses—and put it in writing.
• Create an exit strategy. Decide what happens if one party dies or wants out. Include a buy-sell agreement or succession plans in the property’s operating agreement.
• Keep it personal. Renting a vacation home creates a host of issues that could strain the relationship between the owners. If you don’t need to rent the property to cover expenses, don’t.
courtesy of realtor.com