In a non-arm's length house purchase, steps involve identifying the seller, agreeing on terms, getting an appraisal, hiring legal help, exploring financing, getting tax advice, and recording with local authorities.
A non-arm’s-length transaction means you're buying a house from someone who isn't an arm's length away, in other words, a family member or close friend. You can find advantages to this option: you'll eliminate the competition and the legwork of finding the property that's just right. Instead, you'll be buying a property that you already know. You'll be able to gain insight into the maintenance history and possible issues directly from the owner. However, it's always worth understanding the pros and cons of a non-arm’s-length transaction, including key pitfalls to avoid. Find everything you need below.
Table of ContentsA non-arm’s-length transaction occurs when you purchase a property from someone you know and who has an interest in your well-being (and vice versa). The term non-arm’s-length means the transaction occurs between two people who are close, such as family members or close friends.
A non-arm’s-length transaction occurs whenever the buyer and seller have a personal relationship. This could be a transaction between friends, family or co-workers. Unlike other real estate deals, where the seller and buyer are both only interested in protecting their financial interests, self-interest may not be both parties' primary motivation.
For example, parents or grandparents may choose to sell their home to an adult child or grandchild. Or, one sibling may sell their home to their sibling for under-market value.
Arm’s-length transactions are any standard real estate transaction in which the buyer and seller don't know each other. In contrast, in a non-arm’s-length transaction, the buyer and seller know each other and have a previous personal relationship.
A non-arm's-length transaction is not illegal. However, it may face greater scrutiny because of the greater chance of fraud. For that reason, mortgage lenders prefer to finance arm's-length transactions.
Most commonly, there is a higher probability that the transaction price is not fair market value. For that reason, while a small discount is possible, real estate transactions between related parties must still be made with standard transaction prices.
There are pros and cons of non-arm’s-length transactions. Here is what you might want to consider.
If you're ready to buy a house from a family member, here are the steps to secure a successful transaction.
While a modest discount for transactions between family members is possible, for a successful non-arm’s-length transaction, you'll need to set a fair price based on the current market rates.
If the seller chooses to accept a price under market value, this is considered a gift of equity. The difference between the sale price and the fair market price is the gift of equity.
A gift of equity has to meet specific requirements:
One of the best ways to set a fair market price is to get a professional appraisal. You'll also need a home appraisal to secure a mortgage, and it's required in case of a gift of equity.
A professional home inspection will verify the condition of the home and identify issues that will need repair in the near future. This includes verification of the condition of major home systems.
A real estate lawyer can draft and review the sales contract to ensure it protects the interests of both parties and that any gifts of equity are properly documented.
The lawyer will also help you finalize the purchase agreement, which outlines all aspects of the transaction, including the price and any contingencies.
In addition to seller financing or a traditional mortgage, you could consider a government-backed mortgage or a combination of seller financing and a mortgage. Be aware that your mortgage may not be approved if your family member isn’t current on their mortgage. It's a good idea to confirm this with them before proceeding. An experienced real estate attorney can help make sure you don’t make any costly mistakes.
Even if you trust your relative, you'll need to hire a title company to perform a title search and confirm that there are no unexpected liens on the property. If you're getting a mortgage, your lender will require a title insurance policy, and it's worth purchasing one for your own benefit.
Find some of Benzinga's best mortgage companies for a non-arm’s-length transaction here.
A non-arm’s-length transaction offers a lot of advantages if you have a family member or friend willing to sell their property to you. However, whether you're buying or selling in a non-arm’s-length transaction, it's important to carefully take steps to protect both parties in a non-arm’s-length transaction. If you are ready to move ahead, you can check out the best mortgage lenders for first-time homebuyers. Or check out the best online lenders or conventional lenders.
Yes, FHA and USDA loans allow non-arm’s-length transactions, but with specific restrictions. VA loans don’t allow non-arm’s-length transactions.
There’s no need to prove a non-arm’s-length transaction, although you’ll need to follow specific procedures to meet lender requirements. For example, you’ll need a home appraisal and home inspection.
No, a short sale is not considered a non-arm’s-length transaction. In fact, in short sales mortgage lenders often want both parties to confirm that the sale is an arm’s-length transaction.