3

The scenario:
I have a cousin C who will be left (they've seen the will in advance) their parent's house jointly with their sibling S. The will has a provision for C to buy out S's share at a pre-determined fraction of an independent appraiser's assessment price.

The assertion:
C asserts that in the event of their parent's death, they will easily be able to obtain a mortgage because they "will already have half-equity in the house". For assessment purposes, assume C has good credit (high 700s FICO score), sufficient income and no other outstanding debts.

The question(s):

  1. Is C correct in their assessment of the presumed equity holdings, that is, do they own half the equity, or are they buying a house for half price?

  2. Is C correct that this situation (regardless of the answer to part 1) will make it easier for them to obtain a home loan than normal?

  • Are you sure the ownership by the siblings will be as "joint tenants"? If so, there are complicated rules about selling or buying such a property... – DJohnM Feb 3 '17 at 23:50
  • @DJohnM: There will be no "joint tenants". Per the will, C gets the option to buy S out. If C does not, S gets the option to buy C out. If S does not, the house is sold and the proceeds divided evenly between C and S. – sharur Feb 3 '17 at 23:53
7

Your cousin should be able to obtain a loan on favorable terms. The actual legal document that will be signed by your cousin's sibling is a quit claim deed. This is basically a form assigning sole ownership to your cousin. On that form they can usually list a dollar amount exchanged for quitting claim. But yes, this is essentially a case of two owners having equity in the house, and one of the owners trading cash for the other owner's share.

Your cousin also plans to add a mortgage to this new property that he/she has become the sole-owner of through quit claim. This should be a mortgage with a 50% LTV ratio. The mortgage company wants a deed that has only your cousin on it, so all of the paperwork is prepared in advance so that the mortgage papers are signed at the same time as the quit claim with a title company or escrow company overseeing the signing of all documents at the same time, after which, the mortgage will fund, and the sibling will receive a payment from the proceeds of that mortgage.

Is C correct in their assessment of the presumed equity holdings, that is, do they own half the equity, or are they buying a house for half price?

Neither, they are buying half of a house at full price. (They already own the other half of the house.)

Is C correct that this situation (regardless of the answer to part 1) will make it easier for them to obtain a home loan than normal?

Yes, most mortgage companies are happy to offer favorable terms for mortgages that have less than 80% LTV, and less then 50% LTV for the best terms.

5

The reason a bank wants you to have 'equity' in your house (meaning, value that you hold free and clear, without anyone else being owed money for it) is that it makes it harder for you to ignore your obligations and run away. ie: if you own a house worth $200k, and owe the bank $150k, you wouldn't stop paying your mortgage and move to Venezuela, because you would be losing the net $50k equity that you have in the house.

Having equity in the house also helps when/if the value of property declines. In the above example, if house prices dropped 10%, your house would be worth $180k, but you would still only owe the bank $150k, and would thus still have 'equity' in the house. This again makes it less likely you want to run away from your obligations, meaning the bank will continue to get their mortgage payments.

With that in mind, consider your questions:

Your cousin will, at the end of all the paperwork, own a house worth market price, on which they will owe the bank only a fraction of half the value of. ie: if the value of the house determined by the appraiser is $100k, then they will owe the bank only for the amount of money needed to by out their sibling's $50k ownership portion. If the will says, for example, that they must pay 90% of the appraisal value for that remaining portion, then they would end up taking a mortgage of $45k, and would own a house worth $100k (this means they would have 'equity' of 55k).

There are limits on how much a bank will lend compared with your equity %. Some limits are defined by your national government, and some are limits that the bank imposes on itself to limit its risk. Typically, having between 5-20% equity in the house is considered good / 'good enough'. This implies that with a reasonable credit rating, your cousin would be very likely to get a mortgage from the bank.

2

Is C correct in their assessment of the presumed equity holdings, that is, do they own half the equity, or are they buying a house for half price?

They would own half the equity. If they are each left a share, then they each own half the property regardless of whether one buys the other out. This is called a jointly owned property. In this scenario, C and S should consult the executor of the will for clarification, however, if anything is confusing.

Is C correct that this situation (regardless of the answer to part 1) will make it easier for them to obtain a home loan than normal?

Since C is only applying for a loan for half the amount, he is more likely to be approved. This is because the bank will want to minimize the risk the take on by approving a new loan. Not only will the risk a smaller amount of capital by issuing a smaller loan, but it is more likely that C will be able to pay back a smaller loan.

-1

Having equity isn't the only issue. The reason the bank wants you to have equity is so that there is something they can foreclose on and sell if you don't make payments. Selling an undivided half interest in property is a nightmare: nobody outside the family will buy a half-interest that's shared with C, so in the event of a foreclosure, the bank won't be able to sell their foreclosed half interest. In order to get their money they would have to work something out with C, either informally or through a court action seeking to have the property split between the bank and C. That's called an "action for partition", and the result could be a court order cutting the property in half or an order to sell the property and split the proceeds. The bank would be buying litigation, and that's not something they'll do lightly.

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