Expert: liznarr - 1/15/2009

Question
QUESTION: Hello, I had some general questions about options available to me specifically in terms of purchasing a home, or a percentage of a home from one of my family members. I am drawing something of a proposal up to approach a relative of mine with, who is also my employer, about purchasing a home he owns. This home sits on a few acres of property, and my end goal is to eventually own the property and the house that is located on it. He is fully aware of my financial situation, as my job is my family’s sole source of income.

The house is situated on what I expect would be about five acres; it has a large shed out back, and a decently sized barn in front. A long drive and a detached garage/pump house next to it. The entire property is fenced and well kept.   

The thought that I had, but do not know enough information about to discuss knowledgably, is that I might be able to take on a share of the mortgage, or perhaps purchase a percentage of interest into the property. It is a small, older, two story, ranch style house. I am a veteran and qualify for a VA loan. From the research I have done up to this point I have found I can afford a loan for around $180,000.00. That is only an estimate that is based on a sit down with one mortgage broker and a lot of different online mortgage calculators. I am curious to know what my options and my relatives options are in terms of my purchasing percentage of ownership into the home. I have heard of Joint Tenancy, Tenants in Common, land leases, and other such options. But I do not know what would be the best for both me and my relative. I don’t want anything gifted to me, but I want to be able to pay off a portion of the mortgage and eventually set myself up with the option to buy him out once I am more financially situated for it.

My goal is to get my foot in the door, and provide a long term investment towards where I want to end up raising my family with my wife. While at the same time offering a substantial amount of security to my relative if, for some reason, things don’t work out. He needs to feel like his tail is covered no matter which way the events go. From my understanding of things he does not want to own this house and the surrounding property forever. And I would like to purchase everything, but cannot afford it right now. He is currently renting the property out to a family on what I believe to be a three month lease.

If all I can afford is a percentage of that value of the property, would I be able to buy into an existing mortgage to take some of the burden off him and begin building equity?  What are the options available to both him and me?

My thinking is that we may be able to write contract specifications out which would state that, if the type of purchase I am looking at goes forward, I would have first right of purchase to the rest of the property, when I could afford to do so. Subsequently, if I choose to back out of the property for any reason, he would retain control over it and should he choose to sell to another interested party I would recoup only the percentage of interest I held in the home, providing him peace of mind should things go either direction. All these specifications can be altered or adjusted as necessary, but I hope I have expressed my idea clearly.

I need some input on this, to know what the available options are for both of us. I am 22 years old, married with two daughters. I have never dealt with any type of real estate before, and do not know what is possible. If you are unable to provide me with the advisement or information I am looking for, I would be very grateful if you can direct me towards someone who could. Thank you very much for you time and help.


ANSWER: Hi Tim,

I want to applaud you on your direction of thoughts and how you want to prepare for the future, while only being 22 years old.

First things first.  You need to know what the property is worth before you can do anything.  You can ballpark it initially, but at a point, you would want to have an appraisal done to establish current value if you buy into a percentage of ownership.

You said you qualify for a VA loan of $180,000.  Would you be comfortable with the loan payments on that amount of money?

I understand that you want the family member/employer to feel comfortable, but your wife ALSO needs to be VERY comfortable with any agreement you make.  Should you leave this life before the family member does, you want to insure that your wife and any children still living at home will still have a place to stay and cannot be booted out.  You, your wife, and also the family member could all take title as Joint Tenants.  But think about this:  What if you and your wife both were in a fatal accident and had children still living at home?  In such a situation in Joint Tenancy, the title would then go to the family member; and your children would have no protection.

I, personally, would stay away from a lease or land contract.  You would be throwing money to the wind if you lease.  With a land contract, you would not have title to the property until you paid off your debt in full.  The danger for a purchaser in a land contract is that ANYTIME before the debt is paid in full, if the owner loses the property to foreclosure, tax sale, or to creditors by way of a Judgment, or if an owner files bankruptcy, ANY AND ALL MONEY you had paid to the owner during the term of the land contract would be forfeited, period.  You would have no rights to ownership.

The reasoning behind all the preceding events in a land contract is that when an owner loses the property by any of those means, title changes; there is a new owner; and the new owner more than likely will not even want to know you.

You could not legally take on a share of any existing mortgage without the lender’s approval.  With rates remaining good right now, if you work out a percentage of ownership with the family member; it might be in your best interest to refinance, with all parties being on a new mortgage.

There’s always the possibility that you could purchase a portion now and have the First Right of Refusal on any remaining property should it ever be sold.  An attorney would need to draw up this Agreement, and protection should be in place for establishing fair market value at any later time when you might exercise any First Right of Refusal.

Without knowing the property value, the dynamics of the family member and also your wife, my best advice to you is to …

1.   Establish value, and

2.   Then make an appointment with a real estate attorney and take all your information to him.  Make sure that your wife and any children of the marriage (now and/or later) will be protected in the event the family member outlives you and/or your wife.  After explaining ALL the facts to an attorney, he is best qualified to help advise you as far as how the property should be titled if you work out a deal with the family member.

I’m sorry that I could not be more specific, but perhaps you have some more things now to think about that will point you in a direction you’ve not yet gone.

Good luck to you, and feel free to write again if you have additional questions.

Regards,
Elizabeth

---------- FOLLOW-UP ----------

QUESTION: Elizabeth,

Thank you for taking the time to respond to my initial inquiry, and for the compliments. I have provided some more information, and asked further questions that I hope will not take too much of your time.

You are right; I will need to have an appraisal done before I can expect to proceed with anything. Right now I would ballpark the worth at around $350,000-$400,000 dollars. Land and structures included.

I would be comfortable paying the mortgage payments I have seen for a $180,000 dollar VA loan. A major goal to that end is to in no way overextend myself, I do not want my family suffering at all to try and get a hold of this property. It is important, but not so important that they shouldn’t get the right amount of food on the table every day. That said, I would not be comfortable if I were to pay payments on a loan that is much more than that.

Security is a major reason why I am trying to get as many opinions as possible. People have continued to tell me that a lease/option or a land contract is the way to go in my situation. But I want to make this a true investment, so that if it doesn’t work out for any reason it won’t be a complete loss. But at the same time looking at the situation we are in now, renting out a condo for as much as a mortgage on a $180,000 dollar loan would cost. Our money is not being invested into anything. If I had to do a lease/option I would. But if there is another way I want to know as much as possible to make an informed decision.

I would go into more details if this weren’t a public conversation. But I want this to remain useful for anyone else in a similar situation. My relative has been very successful in the agricultural industry, and has a fairly substantial holding of land and assets. This is in no way meant to bolster my confidence that nothing could happen to him, but to give you a bigger picture of what he has. He owns at least seven similar properties to the one I am looking to buy into, and more than a thousand acres of farmable/pasture land. Most of what he has he owns outright, this is one of the few things left that he has a mortgage on.  He has a substantial financial backing, and through that I hope he has the leniency to work with me, or the lender if need be, in order to come to a comfortable agreement for all parties included.

This is the idea I would like to run with, the lender approving a refinance of the property with all parties on the mortgage. Can my relative and I decide on the percentage of ownership in that situation? Are there any typical stipulations that would restrict a 30 or 40 percent interest on my part? How would the mortgage payments be organized? Would we pay jointly, or send payments in separately? Is that something that is negotiable? Also, if we are not in a 50/50 ownership agreement would it still be considered Joint Tenancy, or would we be Tenants in Common. I would like it set up where I pay him, and he pays the mortgage, or the other way around if need be. With a written contract that sets forth the course of action if one party fails on their end of the obligation. But I do not know what is possible.

You mention the possibility of purchasing a portion now, and having the First Right of Refusal on any remaining property, should he ever choose to sell it. By portion, do you mean a parcel of the property, or a percentage of the entire properties worth? If you mean a parcel, and the property is currently one Tax Parcel, how would it be divided? My assumption would be that we would have it divided, and have the portion I am looking into purchasing appraised. Then I would try to buy just that portion outright. The property is set up with a long driveway that leads to the barn, house, garage/pumphouse and then a shed out back. This is all fenced in separately from the rest of the land. Would the option exist to buy just the house, garge/pumphouse, and access to it? Or, since you don’t know all the specifics, is that something that has been done before? I live in the state of Oregon, and I know every states regulations may be different, but as you can probably see I am looking for a starting point of reference.

I am fortunate that my wife is the most supportive woman I’ve ever known. And she is on board with what I decide, so long as I do the research required to make the best and most secure judgment. I will most certainly make an appointment with a real estate attorney, but I don’t want to act prematurely. I want to be sure to discuss this thoroughly with my relative first. And if he is interested in pursuing this type of commitment, then I would move forward in that manner. Until then I am hoping to get a knowledgeable base to start from so I don’t ignorantly approach him with this. Until you responded, I had been told that my only real option is a lease/option or a land contract. That is what I would have gone to him with, even though it is not exactly what I would like to pursue. So I apologize if I am bombarding you with questions, but what you have spoke of is along the lines of what I have been thinking of for some time. Thank again for the time you’ve take to respond,

Tim  

Answer
Hi Tim,

I’m sending you a very detailed response.  This is probably the lengthiest response ever by me, but I think you are capable of comprehending the different scenarios and thinking “outside the box.”

Responding to your follow up questions ….

I do not see your “only real option” as either a lease/option or a land contract.  I have already explained the dangers of a land contract.  Purchasing from a relative or otherwise, I would never purchase ANYTHING with a land contract.  That’s “my” position, but I respect the fact that others may have different opinions.  A land contract also can also pose some risk for your relative if you did not maintain the property in good repair, pay taxes, etc., if these duties for you were in a land contract.  If you didn’t make payments on time, or if you miss a payment, you risk losing everything you had put into the property.

I don’t know who the people are you refer to, or why, they are telling you the only way to go in your situation is a lease-option or a land contract.  If they know something I don’t, they may have a point; or they may not understand that you are looking for a “safe” INVESTMENT.

Land contracts are typically used when a purchaser has bad credit or cannot come up with a required down payment and is UNABLE to obtain financing through a traditional lender.  You, however, certainly have another option available to you:  You have been pre-qualified for VA loan of $180,000.  Over the years I have seen many people lose 100% of their investment through a land contract.  Many owners sometimes even HOPE that a person defaults on the terms of a land contract so they can take it back at a higher market value (if a number of years have passed with considerable appreciation in the value of the property).   And as you also wrote, you build no equity when you lease property.

I always try to keep an open mind, and you should, also.  Ask these people to give you concrete explanations as to why they believe a lease option or a land contract is a better way for you to go.  Also look at their real estate experience and success in life when evaluating their opinions.  Please don’t agree with me just because you might be hearing what you “want” to hear.  Base any decision you make on sound, practical, business and financial advice.

Do some research on your own.  See if you can locate some financial seminars on this subject, or take a class at a local college.  You can go to Google.com or Yahoo.com and type in key words such as “land contract pitfalls” or “pros and cons of land contracts” (with the parentheses omitted).  I have typed below a few of the sites I pulled up by doing the preceding searches which explain some of the pitfalls to the buyer.  As you will read, there can also be pitfalls for the Seller, but my comments are directed to protect you as a purchaser.  Remember, too, that everything you read on the internet may not be totally accurate or true.

http://www.wisegeek.com/what-is-a-land-contract.htm   

http://www.standardlegal.com/law-library/Land-Contract-Overview.html

http://www.ncrec.state.nc.us/bulletin/vol14-4bulletin/land_contracts.htm

http://realtytimes.com/rtguide/rtcpages/Land_Contract_Pros_And_Cons

http://www.signonsandiego.com/uniontrib/20070429/news_1h29mailbag.html  

A land contract could also be invalidated by a lender holding a mortgage on property if there is a provision in the mortgage that the owner have possession of the property -- or if there is a Due on Sale/Acceleration clause in the mortgage.  Again, when you speak with a real estate attorney, you will get the proper legal advice you need for your State of Oregon.  

If you want to see a copy of the mortgage on this property, you can get one by visiting the office of the Clerk of Court or RMC office (Register of Mesne Conveyances) for the County in which the property is located.  There are employees at these offices who, when given the property address, can pull a copy of any existing mortgage that is recorded.

I cannot stress strongly enough the need for you to go ahead and speak with a real estate attorney to get accurate LEGAL advice for all the pros and cons of land contracts and lease options versus an outright purchase in your situation.  You may even want to speak with an attorney more than once after you digest some initial information from him/her.  It sounds like you have many people advising you, and you have to make a decision that is best for you – but make your decision after first making yourself an informed buyer, making sure you have accurate information.

Answering one of you questions, if you and your relative were to both be on the same mortgage (in the event of a refinance), a SEPARATE check should always be made out for your portion, MADE PAYABLE TO THE MORTGAGE COMPANY and given to your relative to be mailed to the mortgage company (if this is the arrangement you were to agree on).  This way, you would always have proof that you paid YOUR portion of the mortgage; and you can track your checks to make sure they were, in fact, presented to the bank for payment … and cleared the bank.  Your relative would simply make his check out to the bank for the remaining balance of the monthly mortgage payment.

Generally, when people own property jointly, they own a percentage of the total property value, not the physical property.  You could not, realistically, physically split a house in half.  In your case, you could stipulate that you are purchasing, say, the house and 1 acre; or the house and 3 acres; or 5 acres and no house; or whatever you agree to.  

You could purchase $80,000 worth of land and the house; or you could purchase $180,000 worth of the land—not including the house-- and lease the house (with an Option to Purchase) for a nominal amount annually ($100, $1000) --  again, whatever you two agree on in exchange for your keeping the house in good repair and maintained, paying the property taxes, insurance, etc.  I think you can see from these examples all the different ways you could structure an agreement.

Whatever you end up purchasing, you would, of course, want to have deeded access to your portion of the property (not an easement that could be changed later and create a troublesome drive to the house).  You cannot be landlocked; and language for deeded access should be included in your deed.

Keep in mind, also, that when a large tract of land is subdivided (even if 10 acres are split off), many counties have rollback taxes.  By way of example, in the area where I live and work, when property is sold and the use of the land will be changed (as from agricultural rating to a single family dwelling or from agricultural to development for housing), the laws here dictate that rollback taxes will apply … and SOMEONE (either purchaser or seller) has to pay taxes on the PRECEDING five years at any new, higher rate determined to be due because of a rollback tax situation.

If Oregon and/or your county have rollback taxes, this is something else you need to address.  You can find this out by calling your county assessor’s office.  The county should be able to estimate rollback taxes due if this applies and you know how much property you would be purchasing.  Of course, the goal is to NOT change the use of property.  If rollback taxes do apply, ask your real estate attorney more about this when you schedule your appointment.

There are numerous different factors that can be involved in a transaction like you are considering.  I am not trying to address each and every one that could be involved, so that is why you must have a good real estate attorney properly advise you and then guide you through your final procedure when and if you and your relative reach an agreement.  

As an EXAMPLE:  If your relative has other substantial real estate holdings that are mortgage-free, IF – and this may be a big IF – but “if” his bank would substitute collateral on the current mortgage on this property by placing the mortgage against another of his properties currently mortgage-free, you could then secure a mortgage of your own for “X” percentage of ownership for the $180,000.00.  You would then be in a first mortgage position and not have the worry of “what if the relative defaulted on his mortgage, for any reason, intentional, UNintentional, or whatever.”  In this scenario, you would definitely want to have some type of protection in your Deed for an Option to purchase the balance of the property during YOUR lifetime.

I don’t know your relationship with your relative, but if he is willing to work with you wants to help you purchase all the property, you could purchase whatever amount of the property you two agree on with a mortgage of $180,000, possibly with an unrestricted, irrevocable Option to purchase the remainder of the property during YOUR lifetime, not the relative’s lifetime (for a very nominal fee of, say, $100.00).  You might include wording that the election DATE would be within 30 days of the repayment IN FULL of your $180,000 mortgage, or at anytime sooner if you had the means to obtain financing for all the property.  This would be with the understanding that your relative’s current mortgage is paid off or there is a substitution of collateral, removing his existing mortgage.  You do not want to be in a second mortgage position.

When you meet with a real estate attorney, he can explain more about options to you.  Options have several important requirements, including  (1)  The consideration for the option (payment of money to your relative); (2)  the price of the option, the property in this case; (3) the election date (when you have to announce whether or not you will exercise the option); (4) the exercise date; and (5) an expiration date, if the Option is NOT exercised.  

In joint ownership of property (either Joint Tenancy or Tenants in Common), in most situations a property would not physically be divided, but rather a division by the percentage of ownership interest.  As additional information, a deed for Joint Tenancy can only be created if the parties have EQUAL ownership interest.   Therefore, in the preceding paragraph scenario, if your ownership interest were less than 50% you would be a Tenant in Common with your relative.  

As a Tenant in Common, there can also be pitfalls if your relative predeceased you and left his portion to another person or a number of persons via a Will.  The person(s) inheriting his portion could suddenly decide they want to sell the property and cash in on the equity.  If you did not agree, the other owner(s) could file a Right to Partition to try and force a sale.    

In Joint Tenancy, there can also be a pitfall for you.  A provision of joint tenancy is when the first of two titled owners dies, the property automatically reverts to a fee simple ownership to the other titled owner; so Joint Tenancy would not be to your best advantage if you were to predecease your relative and ownership reverted to your relative, leaving your wife and children with no home.

As you can see, there are pitfalls everywhere just waiting for you.  The only really safe avenue for you, in my opinion, is an outright purchase; but I cannot give you legal advice, so this is, again, why it is imperative for you to speak with a real estate attorney.  Since you cannot afford all the property now, ask your relative about doing owner financing, period, on the entire property (NOT a land contract); but only if there would also be a substitution of collateral to remove his existing mortgage (so that your mortgage to your relative would be a FIRST mortgage).

If your relative wants to help you and agrees to owner financing on the entire property, you could make payments directly to him at whatever terms the two of you can agree on.  If, for example, you had to do a FIFTY-year mortgage, OR LONGER, to get the payments you can afford on the entire property, that might be a possibility if this is a close relative who wants to help you.  If your relative had passed on before the fifty-years passed and/or whenever you paid the mortgage in full, the payments would then be made to his heirs (hopefully, one of which might be you).

I’m not trying to suggest that you should do any of the above, because your personal situation dictates what you may or may not be able to, or want to, do.  I am merely trying to get you to put on a different hat and think OUTSIDE the box.  In contract law, anything that is LEGAL can be agreed upon by two qualified parties; so your options are unlimited.

None of my comments regarding your relative are meant to be taken in a disparaging manner.  If you enter into an arrangement with your relative, you and he will be partners in a business transaction; and I am giving you what I consider my best advice to protect YOU.  Whatever decision you make, be sure that you are not getting into a financial contract that you may not be able to fulfill in the event of job loss, accident, or chronic illness.  

A declining term life policy at your young age might also be a good idea to protect your family to cover the amount of any mortgage you create should you meet an untimely demise.  This would pay off any mortgage balance and allow your wife and children to continue living mortgage-free in the property.   If you consider this, do shop around for declining term rates, as they can vary a great deal from company to company.  Bank-offered rates are notoriously high.

You can be creative and add to, delete, or replace entirely any of my suggestions.

Please let me know your final decision, whenever that is.  You can go through the All Experts’ site and send me your personal email address at that time, and I will communicate directly with you then.  Even if you do nothing now, you will be gaining an education in this area that will benefit you later.

I hope the above has been helpful.  Again, feel free to write again if you have another question, and don’t forget to rate my answers.

Regards,
Elizabeth