Some people looking for a home in their retirement years buy a property from a child or another relative. This may seem like an easier choice than purchasing a house from a total stranger. However, a real estate transaction with a family member could prove difficult.
Transactions between relatives, friends or even business associates are non-arm’s length transactions. Mortgage lenders and regulatory agencies scrutinize these deals more closely. Still, with proper planning and care, you can successfully purchase property from someone you know.
Reasons lenders can be skeptical
In a non-arm’s length transaction, the buyer and seller know each other. This contrasts with an arm’s length purchase between strangers negotiating purely in their own interests.
Lenders generally prefer financing arm’s length transactions because they want to make sure the price you are paying is fair and not artificially inflated or deflated due to your relationship with the seller. This is because lenders have concerns that a seller and buyer who know each other might conspire to manipulate the price.
Steps to complete a non-arm’s length deal
If you plan to purchase a home from family or friends, anticipate providing extra documentation to a lender. You may need to get appraisals proving the price aligns with similar homes in the area. Expect lenders to examine the deal closely to verify there is no fraud or price manipulation.
Certain types of mortgages have extra restrictions on non-arm’s length deals. For example, the Federal Housing Administration reports that an FHA loan requires a down payment of 3.5% of the home buying price for an arm’s length transaction but no less than 15% if you buy from someone you know. However, FHA loans may offer lower rates if you purchase from a fiancé or relative.
Advantages in buying from a relative
Purchasing from family or friends can still provide benefits. You may be able to negotiate a better price from an individual who wants to assist you. Closing costs can be lower since you likely will not use a real estate agent. Since buyers and sellers know each other, you may enjoy greater flexibility in establishing a closing date.
With proper precautions, buying real estate from someone you know can still be a good option. Just anticipate extra time for paperwork and inspections to satisfy lender requirements. Do your due diligence to ensure the price aligns with fair market values. Buying a home from family or friends can be rewarding when done right.
