What are fair methods to buy out an equal share holder in a mortgaged property?

Question

TLDR:

What are fair methods to buy out an equal share holder in a mortgaged property?

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Curent situation:

• My partner and I, and her parents have entered in to a mortgage on a piece of land. It is understood (verbal agreement only) that my partner and I 'own' half of the land and her parents the other half .

• The deposit amounted to 1/3 the cost of the land and was covered equally by each party.

• We have since made regular payments towards the mortgage in equal balance, at a rate that is taking care of the interest and some of the principal.

• The land valuation has increased such that if it sold at that value, we'd get back our deposit and effectively have been putting our mortgage repayments in to a low-interest saving account.

• My partner's parents went in to this to give us a step up in to land ownership and had plans to live there occasionally when they retired (we had plans to build on the land). Due to life changes they no longer have plans to live there and are effectively just helping us out. Although I'm just guessing, they may have justified it financially as a longer term investment.

• My partner's parent's financial situation is no longer stable and we feel it would be prudent to seperate financially and 'buy them out'.

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What is a fair way to go about this:

• In the case that there is the interpersonal dimension of parent/child relationships to account for.
• In the case that there isn't.

(should there be a difference?)

Options as we see them:

1. Pay them the sum of their deposit and mortgage payments up until this point?
2. Pay them half of the valuation?

Some other method?

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Yes, we should have considered this beforehand! Although it was discussed between my partner and I, we stopped short of talking to her parents.

I have searched for similar questions, of which there are a few, however they either deal with more complex cases (unequal distributions of payments), or they are relevant, but unanswered due to not giving enough information.

Answer 1

Paying them something like half the valuation of the equity is the fair way that would be used in a divorce or similar situation. Usually this is done by selling the property and splitting the proceeds, but you can certainly agree between you to simply buy them out. In this situation, either side could dispute the valuation as high or low. Selling simplifies this in that the sale price becomes the valuation.

You calculate the equity by looking at how much the current principal is compared to the original valuation. So if the original valuation was $150k and you each deposited $25k and borrowed $50k and have since reduced that $50k to $30k. You would each have $45k of equity in the original loan. That would be 60% of the original $150k. You'd owe $60k on the original loan. So if the current valuation were $200k, you'd each have $70k of equity (half of $140k). You'd pay your partner's parents $70k for their portion.

Equity = Current value - remaining loan
$140k = $200k - $60k

That's the total equity for both pairs. They'd own half of that in your case (because they've made exactly half the payments).

It would also be reasonable to pay them what they put into it, perhaps with some kind of interest. The interest would be to cover the interest that you did not pay, so it would be equal to the interest the bank is charging. Quick example, assuming 3% interest compounded monthly (.25% a month):

Month    Payment Interest Balance
January  $10,000          $10,000
February   $1000 $25      $11,025
March      $1000 $27.56   $12,052.56

You can throw that into a spreadsheet to calculate.

If the second method is more than the first, you would tend to use the first (valuation) instead. If the second is less than the first, you might use it if they wanted to help you out. This still gives them a lump sum of money if they are currently short.

You would generally refinance the mortgage so that their names are no longer on it. You would increase the total amount borrowed so that you can buy them out. So if the equity is currently two thirds, it might drop to one third when you buy their half. You probably should split the fees evenly.

To go back to the previous example. You'd owe $60k on the loan and $70k to your partner's parents. So you'd refinance $130k on the mortgage and start with $70k of equity. Fees of $20k would change that to $140k and $60k if the two pairs split them evenly.

Valuation is the arms length method. Paying back what they put into it is the kind of thing family members might do to help each other out.

Answer 2

The financially-fairest way would be to sell the property and split the proceeds equally.

If you don’t want to sell the property (yet), it gets trickier. The profits are only paper profits until you sell, so it doesn’t give you any actual money to split at this point. Taking this view, and taking the original intent of your partner’s parents to give you a head start on home ownership (i.e. they weren’t expecting property investment returns), you could say that they have given up the dollar-value of their contribution and its opportunity cost.

From that perspective, a financially-fair return of funds would be to hand back their contribution with interest.

Having said that, there is an argument across quite a wide gamut:

• return nothing: it was a gift (but unless that’s what your partner’s parents really offer, this is spitting in the face of people who have been kind to you);

• return the cash contributed: there’s no interest charged within the family on non-investment matters;

• return cash + reasonable interest;

• return cash + its share of paper profits; or even

• don’t account for the dollar value they contributed; instead, make your own contributions towards their needs. Your contributions might even exceed what they provided (or not); the fairness is in the sense of returning the favour of them helping out generously when they were financially secure and you weren’t.

Which you pick depends very much on the nature of the relationship you and your partner have with her parents. From what you’ve written in your question, I get the impression that it’s not the amount but the practical and meaningful contribution that matters to them. Now that their financial position has changed, you’ve done well to consider reciprocating.

Answer 3

So you (with your partner) and your partner's parents own equal shares and paid equal shares. You paid equal shares of the deposit and equal shares of the mortgage, and you owe equal shares of the mortgage.

If you sold the land, it would be easy: You take the money, pay back the mortgage, and equally share what remains. You are not selling, but you can calculate how much you and your partner's parents would get each if you sold. Say the land was $120,000, you paid $40,000 deposit and the mortgage is still $80,000 today, and you could sell for $140,000. There would be $140,000 - $80,000 = $60,000 left after repaying the mortgage, so each party would get $30,000 if you sold today (you obviously pick your own numbers). That's what your partner's parents would get (and what you would get) if you sold today.

Since you are not selling today, and taking these numbers, there are two possibilities: You either pay $30,000, own the complete land, and owe the complete mortgage. You may have to increase the mortgage to get the $30,000. Or the other possibility, you set up a contract that you will pay $30,000 plus interest when you sell the land to your partner's parents - and you own the land, and owe the complete mortgage.

You could do something in between, like repay their deposit ($20,000) and pay $10,000 with interest later when you sell.