What's a house between friends?

Paul Cottingham
Age: 32
Lives in:London
Occupation: Corporate financier
Earns: ?33,000 a year
Mortgage: ?60,000
Debts: None
Investments: LloydsTSB cash Isa; ?3,000 in Cahoot bank; Lloyds Bank Golden Account
Pensions: One frozen; one current company scheme
Aim: To buy a house in London jointly with a friend

Paul Cottingham found a great way to save money: have a wisdom tooth taken out and then sit exams. He could not go out during April and May while enduring the pain so he spent little money.

Now he is back to normal: 'It's feast and famine. I like to socialise a lot. I have one skiing holiday and one summer holiday a year and the occasional weekend away for a rugby match or stag party.' His savings will be wiped out next year when he visits Australia for the Rugby World Cup.

In 1996, while he was living in Cambridge, Paul bought a converted telephone exchange for £68,000. It is currently worth up to £145,000. He borrowed £60,000, using a £20,000 endowment taken out on his twenty-first birthday and the rest as a repayment mortgage, with the first two years at a cut rate and then tied in at standard rate for the next five.

In February 1999, Paul gave up his £45,000-a-year job in Cambridge to travel round the world: Africa, Australia, New Zealand, Fiji, Hawaii, Los Angeles and New York. While he was away, he rented out the house. In March 2000 he settled in London where he rents a room from friends.

He decided to change careers: 'I started work with PricewaterhouseCoopers in October 2000 on the graduate scheme in their valuation and strategy department on a starting salary of £26,000.' He joined the company pension scheme and still has five years' of pension frozen with his previous employer.

Last year, he was shopping around for a new mortgage on the Cambridge house and threatened to leave Birmingham Midshires unless they gave him a better deal: 'They offered me a discount mortgage of 1.6 per cent off their base rate until 1 May 2004, which is the tie-in date.'

His mortgage costs £310 a month but he also pays house insurance and endowment premiums. He still rents out the old telephone exchange for £700 a month and uses some of the rent to pay for his dental treatment which is costing £118 a month until December 2003.

Paul is now thinking of buying a house in London, which is obviously expensive. He is trying to decide whether to remortgage the Cambridge house to raise the money for a deposit, and wonders how much he can spend on a new home. He would like a large place and is thinking about buying with a friend but asks: 'He is a very good mate and we get on well but should I risk a friendship over buying a house?'

Adviser 1: David Bitner

Paul already has an attractive mortgage deal with penalties for switching, so remortgaging is not a good idea. Taking a further advance with Birmingham Midshires is the most suitable alternative.

In theory he could borrow 85 per cent of his existing house, giving a mortgage of ?115,000. This, less his current loan of ?60,000, means he could raise in the region of ?55,000 from his existing property.

Based on an income multiple of 3.5 times salary, he can raise approximately ?115,500. With a deposit of ?55,000, he could look at property up to ?170,000 at the top end. The larger the deposit he puts down, the more attractive the deal.

Rates are likely to be depressed well into 2003 so fixed-rate mortgages are becoming more attractive but they are about 1 per cent higher than discount rates.

Affordability is the key and, if Paul can still afford the mortgage payments at 2 per cent above today's levels, a discount would be the most appropriate. If he takes out the full mortgage, he should concentrate on repaying the loan on his own home before paying the mortgage on his let property.

There are considerable drawbacks to buying with a friend. What if one wants to get out of the mortgage arrangements or can no longer contribute? A written agreement is essential.

David Bitner is director of the MarketPlace financial advisers at Bradford & Bingley.

Adviser 2: Peter Brennan

First, Paul should consider the risk of borrowing too much. House values do not always go up, and rented properties have periods unlet.

He should sort out his short- and medium-term needs, and build a cash reserve in case he fails to receive rents or becomes unemployed.

After paying penalties and costs, remortgaging might release ?40,000 as a deposit, which allows him to consider properties worth around ?300,000. But while a lender may offer such terms, this does not mean he should take them. He should budget for what he can afford rather than the amount he can borrow.

Paul should check whether his endowment policy is still appropriate and possibly convert his existing loan to a repayment basis.

No tenants would agree to link their rent to mortgage rates so why should the landlord carry the risk? Paul should consider a capped or fixed-rate loan so he knows what his costs will be.

He should buy with a friend only if both draw up separate legal documents with 'break' clauses to cover changes in circumstances.

He could transfer his frozen pension to his existing scheme if there is an obvious advantage in doing so. To find out, he should ask the trustees what terms they will offer him.

Peter Brennan is a personal finance consultant with Advisory & Brokerage Services.

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