1

My partner and I are looking to buy a home together in California and set up a contract for splitting the equity. I would pay the 20% downpayment on my own, and thereafter my partner and I would split mortgage payments 50%-50%.

All the examples I've found for joint ownership contracts show an equity split that remains constant over time, e.g. 70%-30% split between partners. But in this scenario, each partner's share of equity would vary over time.

We would like a contract where:

  • The initial 20% equity following the downpayment is split 20%-0% (i.e. one partner gets all of the equity from the downpayment, the other partner gets nothing, and the 80% balance goes into the mortgage)

  • With each mortgage payment, we each increase our share of the equity by an equal amount until the mortgage is paid off.

  • If we split up any time before the mortgage is paid off, the equity split would be (20% + .5X) for one partner, and .5X for the other, where X is the total equity acquired via the mortgage payments.

  • When the mortgage is fully paid the resulting equity split would be 60%-40% -- again, that's (20% + .5X) for one partner, and .5X for the other.

Is this possible?

5
  • 1
    Make your life simple. Draw up a contract which states that you own 60% of the house because you paid 20% for the down payment. Use a lawyer. Might be a good idea to include provisions that give both parties the ability to force a sale should one party become a deadbeat (non payment). Nov 15 '21 at 20:31
  • 2
    Just seconding the recommendation to use a lawyer to draw up a contract. DIY contracts are bad enough by themselves but for a high-stakes transaction like a home you don't want a DIY solution.
    – jwh20
    Nov 15 '21 at 21:09
  • X is fairly easy, if tedious, to calculate based on your mortgage documents and/or monthly statements; or with a spreadsheet. So if you've already made a decision to split based on 20%+0.5X (of initial contract amount, equity is a nebulous amount until a sale occurs), what is the question? That asked, I concur with previous comments that this calls for a legal advice and a professionally drawn up contract. Nov 15 '21 at 22:01
  • 1
    Another way to do this more simply might be to show the split as 50:50, and have a separate loan agreement set up to show that your spouse's portion of the down payment is something that you loaned them. That loan would then be something to be paid down over time or not. Your bank would need to be aware of this arrangement most likely, and probably still a good idea to consult a lawyer, but could be more straightforward. Nov 16 '21 at 5:12
1

Beyond the need for a lawyer to handle the contract side of things, it's not necessarily equitable to split it as you suggest.

In investment you have a concept of leverage, which is when you invest some money but borrow more in order to make an investment that hopefully returns a greater return than your interest rate on the borrowed money. You put in $20k, borrow $80k at 3% p.a., put that $100k in AMZN or AAPL, and make, say, $20k in two years; you earned ($20k-$4.8k) = $15.2k, which on $100k is an okay 7.6% return, but on $20k is an incredible 75% return!

Your house is the most common form of leverage used by folks in the middle class in the US (and probably most countries). While the standard warning applies - that housing is only sort of an investment, and it shouldn't exactly be treated as such - it makes sense to look at it through that lens in this case.

Let's say you buy a house for $1M, and you put in $200k. Then you live in it for five years, and sell it at the end. Payments are, say, $60k/year, and for simplicity let's assume of that a flat $12k/year goes to principal (this is inaccurate, but not important). What are the possible outcomes?

Sale Amt Mtg Balnc Equity Paid(P1) Paid(P2) Proceeds(P1) Proceeds(P2) Return(P1) Return(P2)
$800,000 $740,000 $60,000 $350,000 $150,000 ? ? ? ?
$1,000,000 $740,000 $260,000 $350,000 $150,000 $230,000 $30,000 (34%) (80%)
$1,200,000 $740,000 $460,000 $350,000 $150,000 $330,000 $130,000 (6%) (13%)
$1,300,000 $740,000 $560,000 $350,000 $150,000 $380,000 $180,000 9% 20%
$1,500,000 $740,000 $760,000 $350,000 $150,000 $480,000 $280,000 37% 187%

The first row you'd need to have an answer for in the contract: what if you lose money, and sell for less than the initial cost (s? Are you just giving the $200k person all $60k of the equity, or does the other partner still get some back for their payments?

The next two rows show modest "losses", which aren't true losses in terms of the house losing value, but the property taxes and interest paid aren't being fully recouped in the sale, so you don't end up with as much as you put into it. In both cases there is a negative return for both participants, and the return is "larger" proportionally for the partner with no down payment, though it's the same total dollar value... and odds are they are feeling okay ultimately, as they at least got some value out of the house while living in it.

The final two, though, show where the power of leverage comes in handy: if the house sells for a lot more, P2 is really making out. They're putting in $150k, and they're making almost double their initial investment! If I'm investing money, I want to be P2 here, assuming I believe the house will sell for a net profit.

Where it really becomes a killer deal to be P2, though, is when you consider the cost of renting - basically, without this house they'd be spending that anyway (and not recouping it). Take the table and factor that in, and P2 is ahead in basically every scenario. Let's say the cost to rent a similar house is $50k annually ($250k/5 years), split evenly.

Sale Amt Mtg Balnc Equity Paid(P1) Paid(P2) Proceeds(P1) Proceeds(P2) Return(P1) Return(P2)
$800,000 $740,000 $60,000 $225,000 $25,000 ? ? ? ?
$1,000,000 $740,000 $260,000 $225,000 $25,000 $230,000 $30,000 2% 20%
$1,200,000 $740,000 $460,000 $225,000 $25,000 $330,000 $130,000 47% 420%
$1,300,000 $740,000 $560,000 $225,000 $25,000 $380,000 $180,000 69% 620%
$1,500,000 $740,000 $760,000 $225,000 $25,000 $480,000 $280,000 113% 1020%

In a very optimistic scenario (+50% in 5 years), P1 makes double their money - not bad, a 23% return p.a.. But for P2, they double their money if the house sells for basically anything above the starting amount! Even selling for $1,050,000 they make more than double their input (net of their rent-equivalent costs). And they have nearly no risk - they risk a measly $25k, even if the housing market collapses and the house sells for nothing, while P1 loses their life savings.


So... how do you resolve this?

There are two ways that make sense to me.

The first is to throw this whole post out the window and decide that you're going to acknowledge the emotional/social aspect of this transaction, and agree to something that's realistically unfair to you, but is better for the relationship. This is what most people do, as far as I can tell. In this case, don't try to get so detailed as you have above: do it like I did in the table above. Sale price minus mortgage balance equals equity; you get $200k off the top of that, then equity is split 50/50, no worrying about anything else. Maybe you get that $200k no matter what (so if it loses money, you get all of the equity), that seems like a fair exchange for the partner.

The second is to treat this as you owning the home, and your partner renting it from you - perhaps "rent to own", but where your partner's share in the return is limited. You're taking basically all of the risk, so you get basically all of the windfall. Your partner gets some fixed amount based on the payments - 50% of the principal paid off each month - and then gets some fixed percentage above that amount based on the house's appreciation (so if it sells for 150% of the purchase price, they get their principal payments plus 50%, say). Let's see that table one more time with this example... and we'll pretend they paid off $5k of principal each in the first 5 years for simplicity. We'll also leave in the "rent" factor subtracting from the amount paid, so the more realistic return is seen.

Sale Amt Mtg Balnc Equity Paid(P1) Paid(P2) Proceeds(P1) Proceeds(P2) Return(P1) Return(P2)
$800,000 $740,000 $60,000 $225,000 $25,000 40,000 20,000 (80%) (20%)
$1,000,000 $740,000 $260,000 $225,000 $25,000 $235,000 $25,000 4% 0%
$1,200,000 $740,000 $460,000 $225,000 $25,000 $430,000 $30,000 191% 20%
$1,300,000 $740,000 $560,000 $225,000 $25,000 $527,500 $32,500 234% 30%
$1,500,000 $740,000 $760,000 $225,000 $25,000 $722,500 $37,500 321% 50%

In this second example, they're getting very little back if you sell it in the first several years. It won't feel very fair, as you'll stand to get the far majority of the gains, but it's probably the most fair from a pure investment point of view - remember, odds are you won't even sell for 20% more, and you may well sell for less. They're not at risk for losing much, and their return is still really good compared to what they're putting in! That top line is far more likely than you probably think, especially in California...

4
  • Your equity value/Mtg Balance is off by the downpayment (after 5 years * 48k principal + 200k downpayment, the balance is 540k, not 740k).
    – Solarflare
    Nov 16 '21 at 21:07
  • I am not sure if "substract 25k rent that one would otherwise have paid" is a fair comparison. I'd probably compare it to buying a house without downpayment, but maybe pmi and slightly higher interest rates (maybe 5-10k per year?) - but still keeping most of the "rent" as equity. I like the idea to compensate for the risk of losing the downpayment though, but it feels a bit overvalued in your calculation.
    – Solarflare
    Nov 16 '21 at 21:07
  • 1
    @Solarflare The down payment is $200k on a $1M house - $800k is the initial loan value. They're not paying off $48k/year in principal - they're paying off $12k a year in principal, roughly ($60k total).
    – Joe
    Nov 16 '21 at 21:29
  • The point of reducing by the rent paid is it's the "use value" of the house - it's a cost you have no matter what you do purchase-wise, so it's not a consideration in the actual investment portion. It does make it pretty extreme - but there's a reason that mortgages are by far the main way Americans build wealth.
    – Joe
    Nov 16 '21 at 21:30

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.