People buy and sell homes on a daily basis — and sometimes to and from their own family members. There are a variety of reasons and different ways that family members can ‘gift’ or sell a house. Whether it be a gift of equity, covering the down payment, or a discounted price, there are many ways to sell or buy a home within a family.
You may be wondering about the steps it takes to sell or buy a house from a relative. Whether it is you doing the buying or selling, or if you’re doing research for someone else’s, this article talks about just that. We will discuss the different types of transactions and the necessary steps before we weigh the pros and cons for you.
- Understand the difference between an arm’s length transaction and a non-arm’s length transaction
- Learn the steps to purchasing a home from a family member or friend
- Understand your obligations when purchasing a home through a non-arm’s length transaction
- Tips for purchasing a home from family or friends
Arm’s length vs. non-arm’s length transaction
When it comes to real estate, there are two categories of transactions — arm’s length transactions and non-arm’s length transactions. And it all comes down to the relationship between the buyer and the seller.
Arm’s length transaction
An arm’s length transaction is your typical real estate transaction. There is no professional or personal relationship between the two parties and each side acts with their own best interest in mind. Person A has a house to sell, and Person B has a house to buy. Deal closed.
Non-arm’s length transaction
A non-arm’s length transaction is when the buyer and the seller have a personal relationship. This could mean friends, family, business partners, etc. Personal and self-interest are not always the goal in these transactions. However, it almost seems too good to be true, right?
Steps on buying a house from family members
There are many steps to buying a house in general. And while you may not have to go house hunting, there are still some steps that you need to do before the sale is all said and done. Here are the steps to buying a house from a family member:
1. Get pre-approved
There are some conditions to keep in mind when it comes to the mortgage aspect of it all. For sellers, you want to make sure that the buyer is approved for the mortgage. For buyers, it is good to know if the seller is current on their mortgage payments. If they are not, it might delay the approval for yours.
2. Decide the purchase price
When it comes time to crunch the numbers, there are many ways that the price can change. The first is to determine the fair market value, usually done by an appraiser hired by the seller. Next is to look at options for lowering the price. This is where a gift of equity, cash gift, or covering a down payment or closing costs come into play. Be sure to check with a tax expert first. All of the mentioned gift options have implications on the tax returns of the buyer and seller.
3. Title history and legal representation
As a buyer, you may want to hire a title company. This is not to insulate that your relative is untrustworthy, but it is a good idea to look into the title. That way, you can find out if there are any liens on the house or if anyone else claiming the title. Hiring an attorney is also not a bad idea. They can help both parties avoid mistakes, write and notarize contracts, along with making sure there is no fraud being committed on either side.
4. Complete the purchase agreement
A purchase agreement is a written and legally binding agreement to buy the home for the price that has been agreed on. It can also detail the terms of the sale, gifts, or covered costs made by the seller to the buyer.
5. Underwriting and closing
After all of that is done, then the loan gets processed by the lending agency. This is a good idea to avoid large purchases and activities that will poke holes in the credit score. This helps to get a better interest rate. Upon approval, the closing is done, and the house now belongs to the buyer!
Pros and cons of buying a house from a family member
There are a few things to consider before pursuing this type of transaction. A non-arm’s length transaction does have its benefits, but it also has its downfalls. Here are the pros and cons.
It boils down to this — time and convenience. When buying a home from a family member (or selling, in some cases), there is a lot of energy saved in the process because a lot of the stress is non-existent.
- Cheaper closing costs or down payment: There is no real estate agent involved, which can save the seller commission fees. For the buyer, gifts of equity or cash gifts can be put towards a down payment. Everyone wins!
- No hunting: The buyer does not have to find a house, which can be one of the most stressful steps in home buying. And it helps the seller too! Because the seller doesn’t have to hunt for a buyer and can go into a new place with no contingency.
- Stays in the family: For some people, the land and the home are treasured heirlooms. Or, if the house is in a historical section of town, you can be assured that it will be taken care of. Sometimes it is nice to know that the place you call home is going to be loved as you loved it.
- Flexibility: There is some flexibility with moving, which can be nice. It allows both parties to pack and gives the seller time to find a new place. Not to mention, it is way less of a hassle to try to meet during a certain time frame on a weekday.
There are some disadvantages as well, which is the case with every type of agreement. When it comes to family, there can be a lot of personal life drama that can ruin a deal. Knowing the pitfalls of a non-arm’s length transaction is important, and perhaps you can avoid them.
- More hoops and restrictions: There are more hoops to jump through and more restrictions, and these can vary by lending institution and situation. But there is often a bit more legwork done by the buyer and seller than is usually done by the real estate agent.
- Tax implications: Gifts of equity or other large monetary gifts have to be claimed on tax returns. And sometimes, even the buyer has to claim it as well. Be sure to talk to a tax expert to be sure all things are accounted for.
- Strife: Large and stressful processes like moving can make or break a family. Not to mention, some other family members may feel strongly about the transaction and will put in their two cents. It is good to set boundaries beforehand. And if you think this process might further damage an already fragile relationship, then it may be wise not to go through with it.
- Not a done deal: Sometimes, the buyer may have to back out of the deal, or the seller has to increase the price. These things are very real in the traditional real estate process, and non-arm’s length transactions are not immune.
Are non-arm’s length transactions illegal?
While a non-arm’s length transaction is legal, there is a lot both parties have to do in order to get to the final goal of buying and selling. This is because there is a lot of fraud concerning these transactions, which could mean manipulating the local housing market, inflating the price to cheat the seller out of money, or other forms of misrepresentation. Lenders have to abide by government regulations and guidelines to protect themselves and the parties involved. Some lending institutions may have their own rules regarding non-arm’s length transactions, so be sure to check with your institution before continuing through the process.
What is financial misfeasance?
Financial misfeasance refers to a willful and intentional action that can cause harm. When talking about the mortgage industry and a family sale, it refers to the risk of fraud in terms of the sale. For example, in an arm’s length transaction, buyers and sellers set the prices in the market. Homes will sell for a price based on what buyers are willing to pay as well as what other similar homes in the area have sold for. When a family sells a home to another family member at a below-market price, this can affect the market negatively.
Lender’s regulatory obligations
In a non-arm’s length transaction, lenders must follow specific guidelines in order to protect themselves against mortgage fraud accusations, as well as help maintain the integrity of the housing market. Following these regulations can mean changes for you as a buyer. For example, if you are applying for an FHA loan to purchase the home, the non-arm’s length transaction will require a change in the down payment for the home. With a traditional FHA loan, you can qualify with a 3.5% down payment, however, if the sale is a non-arm’s length transaction, regulations require a 15% or more down payment.
Tips for buying a home from a family member
If you are considering buying a home from a family member, there are a few things to consider first. Following these tips will help ensure that both parties are protected.
- Bring in outside resources: Buying a home from a family member can be a tricky transaction and you want to make sure all involved are protected.
- Bringing in professionals, such as a real estate attorney, real estate agent, title company, and a professional home inspector can help ensure everything is as it should be.
- Get an appraisal: Having a professional come in and perform an appraisal on the property will help establish a fair price and ensure the sale is fair to all parties.
- Get everything in writing: Even if this is a cash sale, you want to make sure that you have everything in writing, such as a purchase agreement, in order to ensure that both sides are legally protected. Again, this is a good reason to hire an attorney.
- Check your legal obligations: While gifts can be a part of the sale price, you want to make sure all gifted funds are documented and that you are meeting IRS rules and tax laws and won’t find yourself in trouble in the end.
Frequently asked questions
What is it called when you buy a house from a family member?
When you purchase a home from a family member, friend, or coworker, you already have a personal relationship on some level. When this occurs, it is referred to as a non-arm’s length transaction.
Is it a good idea to buy a house with a family member?
Buying a home with a family member or friend can be beneficial as long as all parties involved are equally responsible and financially prepared. In addition, you want to get everything in writing and determine what will happen should one member move out and default on the mortgage.
Can I buy my parent’s house for a dollar?
Yes, you can buy your parent’s house for a dollar. However, while you may have purchased the home for a dollar, the IRS still considers the home value when it comes to taxes, and the difference is considered an equity gift. In this case, the actual value of the home, not a dollar, must be reported as a gift on your tax return.
Can I buy my parent’s house for what they owe?
Similar to the question above, yes, you can purchase your parent’s house for the amount they owe on their mortgage. However, the difference between the amount you pay and the value of the home is considered an equity gift and must be claimed on your taxes.
Home purchasing within the family
Whether you are looking to purchase your parent’s home or a friend’s home, there are some special things to consider when purchasing. It is important that you make sure that all parties involved are protected and that you follow the necessary guidelines.
We can help navigate the family home purchase
In many cases, purchasing a home from a friend or family member can be a much easier process than a traditional arm’s length transaction. However, it does require you to follow many additional requirements and, in some cases, can become very overwhelming.
At Hero Home Programs, we strive to help our heroes purchase the home of their dreams, even if it is already in the family. To find out how we can help navigate you through the purchasing process, contact us today.