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I have very good credit that I've worked hard to obtain. My friend has flipped a few properties and made some good money doing so. He wants to pay me a fee along with any taxes I'll endure if I put a place in my name.

He'll pay the down payment, mortgage and any property fees.

  1. What risks am I taking?
  2. What should I base my fee on?
  3. What effect will it have on my credit?
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    Why would a 'well-off' person need to tap your credit? How much is he putting down, i.e. what percent of the value? And how much will the fixing cost? – JoeTaxpayer Feb 5 '14 at 1:20
  • @User58220 - I don't know that I'd be so quick to accuse anyone of deception. The devil is in the details, transferring money can create gift tax issues. You are right that there's also a concern of having the profit in the name of one person but really belonging to another. – JoeTaxpayer Feb 5 '14 at 1:36
  • @JoeTaxpayer: I was thinking of the situation here in Canada, with no gift tax, and no capital gains taxation for one's principle residence, but taxes on a business of flipping houses... – DJohnM Feb 5 '14 at 1:41
  • Since you are talking about getting a mortgage as a straw-man transaction, one could consider this skirts close to the definition of fraud... – ChuckCottrill Feb 5 '14 at 2:25
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    @JoeTaxpayer - a well-off person could want to tap your credit to use leverage, and reduce their risk. And they may have too many deals going to get another loan. – ChuckCottrill Feb 5 '14 at 3:25
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Great, your friend is well-off, and simply wants to have you hold the mortgage in your name. Here are a few of the problems/risks that I can think of:

  • Since you have good credit, how/why does this help your credit?
  • Does your friend want joint title?
  • Does your friend want you to have life insurance on the mortgage held with joint title?
  • Should the real-estate market fail and the property lose value, your friend could bail, and you would be left paying for a property you cannot sell.
  • Can you pay the mortgage if your friend cannot, or will not?
  • Are you willing to own this house if the deal goes bad?
  • Will your friend obtain your SSN (or equivalent)?
  • Whose name is the property title to? Can you sell unilaterally should problems arise?
  • Who puts down money for purchase, and repairs?
  • Who makes the payments? What if your friend forgets, or cannot pay payment (cash flow problems)?
  • Will your friend deposit N payments in advance to ensure payments are timely?
  • Does friend provide funds for down-payment, reserve funds for rehab?
  • What is your extraction plan if you get stuck with a lemon?
  • A truck hits your friend (death, illness), how do you complete the rehab and sale?
  • A truck hits you (death/illness), how does your friend complete the rehab and sale?
  • Do you trust him/her?
  • Does he/she trust you?
  • Could the IRS consider this tax evasion?
  • Could the authorities consider this money laundering?
  • Could the authorities consider this bank fraud?

One strategy to make outsized returns on your investments is to use leverage. Leverage is to use OPM (Other People's Money) to expand the amount of assets you can purchase. Perhaps you invest 10% of your money, and borrow 90%. When the asset increases in price by 10%, you have doubled your money.

Here is a specific example. You invest $20K to buy a $200K property (invest 10%, borrow 90%), and sell the asset later for $250K, but you pay $10K for the use of the 90%. The asset made $50K, a 25% gain. But you made $40K on your $20K investment, a 200% gain on your original investment! Awesome!

But the other $180K only returned $10K, about 4.5%. So you earned 200% and the other party earned less than 5% on a deal that was worth 25% total gain. Suppose this is the deal your friend offers. You are at risk for the 90%, and he is at risk for the 10%, but your friend is offering you the 5% gain to his 200% gain.

Your friend is screwing you royally.

What you are missing is that you are providing most of the money for the deal. You are borrowing the money, but you are still agreeing to repay the debt, so you are providing the majority of the money, the OPM, the leverage. You are carrying the majority of the risk. And you are gaining the minority of the reward. Think of it this way - what if you were not getting a mortgage, but investing your own cash - would you be happy with the small part of the return?

The funny/sad part is that your friend does realize he is using you for leverage, but does not even consider how lopsided the deal, and that he is taking advantage of you.

Fix the deal: You provide 90% of the purchase, your friend provides 10%, you sell and pay costs out of the proceeds. You get 90% of the return, your friend gets 10%.

But the deal doesn't happen. Because then your friend does not get the leverage, and rather than 200%, must settle for 25%. And really, your exposure is much less than the entire mortgage. Pragmatically, you are only risking about 20-30% of the mortgage, so you should get about 2/3 to 3/4 of the gains, while your friend gets 1/3 to 1/4, and probably only gets about a 100% to 130% return on his investment.

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    Suppose you decide you want to purchase a house. Now the bank looks at your mortgage and sees that you already have a mortgage. They are going to more closely examine the loan application, and since you have a house payment, your debt-to-income ratio is much higher, you may be denied the loan. Or they may judge that you are trying to get an "investment" loan, and deny the loan. – ChuckCottrill Feb 7 '14 at 17:13
  • The 'Fix the deal' section is a bit extreme, its true that 50-50 would not be fair, but the work and knowledge should be rewarded somewhat in a fair deal. If I really were to do this, I would go for something like: You may at any time decide whether/when to sell. When selling the property, you get first right to 90% of the original value (so if it drops 10% you don't feel much pain), he invests whatever he likes and if you sell above the purchase price you get 50% of the extra value (value, NOT profit). – Dennis Jaheruddin Mar 1 '17 at 9:43
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    Agreed that work and knowledge should be rewarded and worth some amount. The OP needed to understand the significant value of their part of the investment. The actual percentage split should be negotiated by well informed parties. – ChuckCottrill Mar 1 '17 at 18:28

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