Buying a house from a family member can make sense, especially if it saves you money or makes it easier to get financing.
[A Guide to Seller-Paid Mortgage Rate Buydowns]
Arm’s-Length Transaction vs. Non-Arm’s-Length Transaction
Most people don’t know that their relationship with a seller can have a huge impact on their home financing. There is a big difference between financing an arm’s-length home purchase and a non-arm’s-length purchase.
Arm’s-Length Transaction
An arm’s-length transaction is a sale in which the buyer and seller don’t have a close relationship and have roughly equal bargaining power. Cornell Law School’s Legal Information Institute defines “arm’s-length transaction” as a sale:
— That is voluntary
— Takes place in an open market
— With both parties acting in their own self-interest
In an arm’s-length transaction, the buyer hopes to pay as little as possible, while the seller wants to get the highest price. In a free market, this works to ensure that sales are completed at or near market value with customary terms. Arm’s-length transactions are safer for lenders because the sales price is likely to be at or close to the actual property value.
Non-Arm’s-Length Transaction
A non-arm’s-length transaction is a sale between people who already have a personal or business relationship. They might be family members, friends, co-workers or business partners. A landlord selling a home to a current tenant is also a non-arm’s-length transaction.
Often, non-arm’s-length home sales take place because the seller is downsizing and wants to help out a relative who can’t find a suitable, affordable home. But non-arm’s-length sales can also conceal tax fraud, mortgage fraud or other dishonest dealings.
For example, a con artist could sell a home to a trusting family member for more than its value. Or a colluding employer might agree to purchase an employee’s distressed property in a short sale — and then sell it back for less than the original mortgage balance. Property flipping fraud occurs when a crooked investor buys a property, improves it slightly and then sells at a huge markup to a collaborator (aka, a “straw buyer”). The buyer takes a mortgage based on the artificially inflated home value and both perpetrators walk away, leaving the lender with losses that can’t be recovered.
Mortgage for a Non-Arm’s-Length Transaction
Non-arm’s-length transactions involve some additional documentation because lenders have to make sure that neither party is committing tax fraud, coercing the other or inflating the price for their own gain. The rules for non-arm’s-length home purchases depend on the loan program.
Fannie Mae
Fannie Mae guidelines allow non-arm’s-length transactions. However, there are a few exceptions:
— If you have a relationship with the builder, developer or seller of a new or recently completed home, you can only finance the home as a primary residence.
— Delayed financing is also not allowed for non-arm’s-length sales. Delayed financing means paying cash for a home and immediately getting a cash-out refinance to pull your money out. You’ll have to wait six months before you can complete a cash-out refinance.
Freddie Mac
Freddie Mac also prohibits non-arm’s-length transactions for investment properties. However, it allows them in most other circumstances. Expect more thorough underwriting, though — for example, you won’t be able to save time and money with an appraisal waiver or remote appraisal. All non-arm’s-length transactions must include a complete in-person home appraisal.
FHA
The Federal Housing Administration calls these sales “identity of interest” transactions. With one of these, the minimum FHA down payment increases from 3.5% to 15% unless you qualify for one of these exceptions:
— One family member buying another family member’s primary residence
— Tenants buying a property they’ve rented for at least six months
— A homebuilder’s employee buying a new or model home as a primary residence
— Corporate transfers when the company buys an employee’s home and sells it to another employee
VA
Official Department of Veterans Affairs guidelines do not restrict non-arm’s-length purchases, but individual lenders may choose to prohibit them, or they might finance them only if the home is sold near market value and there are no signs of fraud.
USDA
U.S. Department of Agriculture guidelines allow non-arm’s-length sales as long as existing relationships are disclosed to the property appraiser and gifts of equity are correctly documented.
[READ: Today’s FHA Mortgage Rates]
Giving a Gift of Equity
Real estate purchases between family members sometimes involve a gift of equity. This means the seller transfers some equity in the home to the buyer. If your purchase allows your grandmother to avoid a 6% real estate commission, for instance, she might split the difference and gift you 3% to help with your down payment or closing costs. Or she might be even more generous if you’re close.
“Maybe the niece or the nephew or the relative wouldn’t have the requisite amount of a down payment. So the seller is saying, ‘You know what? I want to help you. I’m going to help you on your path towards homeownership. So whereas normally you might put down $20,000, the $20,000 that you don’t have, we’re going to give you a gift towards that, and then we’ll make the loan balance the difference,’” says Nicholas Tyszka, attorney at Handler Law in Illinois.
Many lenders allow gifts of equity to count toward the down payment as long as the correct paperwork is completed. Gifts of equity must be reported to the IRS. If the gift is greater than the annual exclusion, which is $19,000 in 2025, it counts toward the donor’s lifetime exemption.
Buying a Home From a Relative: Pros and Cons
Buying a home from a family member has its advantages, but it can sometimes lead to awkwardness or misunderstandings. Before agreeing to buy property from a family member, weigh the pros and cons. And don’t forget: You still have to be approved for a mortgage, which can present a hurdle. “Sometimes you do run into a family member that wants to sell their home, but the child or grandchild does not meet the loan guidelines,” Krieger says.
[READ: Compare Current Mortgage Rates]
How to Buy a House From a Family Member
To buy a house from a relative, follow these steps.
Disclose the Relationship Upfront
Compare mortgage quotes, choose a lender and apply for mortgage preapproval. Tell the lender right from the start that you’re planning to buy a home from a relative. “Trying to hide a familial relationship could be fraud, and mortgage fraud has severe penalties. So that’s something that needs to be disclosed at the onset,” Tyszka says.
You’ll need to fill out a form stating that you have a relationship with the seller, and you may also need to write a letter of explanation detailing how you’re related. Make sure that both you and the seller are available to meet with the lender to answer additional questions. “The lender’s going to want to talk to both parties in this, because there’s going to be documentation that we’re going to need from both sides, whereas normally the agents do that work,” Krieger says.
Draft a Purchase and Sale Agreement
You and the seller should agree to the price of the home, which might entail researching comparable home sales online to determine the market value. If you’re receiving equity, you should also decide on the size of the gift.
You’ll need a purchase and sale agreement with the identity of the buyer and seller, a description of the property, details of the price and down payment, and the dates you’ll close the sale and take possession of the property. If the seller is leaving furniture or other personal property, the agreement should state which possessions are being included along with the home. Understand that valuable personal property is often considered a concession or inducement to purchase by mortgage lenders, and including such items in your purchase agreement can result in a dollar-for-dollar reduction to the property value.
A lender can’t give you a blank purchase and sale agreement, so you’ll need to create your own or hire a real estate agent or attorney to draft one for you. If you come up with your own agreement, it’s a good idea to have an attorney review it.
You should investigate the property’s title at this point, too. Although the lender will do its own title search later, checking the title early can help prevent surprises later on. “It’s important because there are things like making sure that the parcel number and all the details of the property are accurate, because you don’t want to accidentally buy a different lot of land,” Krieger says.
Complete the Purchase
As with any home purchase, you’ll need to proceed through the mortgage timeline, including answering questions from underwriters, finding homeowners insurance and selecting providers for closing services.
Have the home inspected. Even if you feel you already know the home well, there may be issues that aren’t readily apparent. Plus, an inspection can give you a heads-up about how soon the home will likely need repairs or new appliances, so you can better budget for homeownership.
Once the lender gives you final approval, you’ll receive your final documents and can schedule closing. Then, you’ll meet with your family member and the closing agent to sign everything and transfer legal ownership.
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Non-Arm’s-Length Transaction: How to Buy a House From a Family Member originally appeared on usnews.com