Your Guide To Buying A House From Family Members

Why Buy A Home From A Family Member?

Buying a home is a huge investment of time and money. While homeownership can be a rewarding experience, the journey to the closing table can be stressful as buyers attempt to avoid buyer's remorse. Buying a home from a relative may reduce some of that stress and help overcome some of those challenges.

You Know The Home

You may have grown up in the home or visited it frequently and already know its ins and outs. You know what you love about it and what you want to change. You’re familiar with the home’s quirks and know how to live with them and maybe even enjoy them. You likely have memories in the home and want to create new ones in the years to come.

You Know The Seller

Knowing the seller likely means you know how they cared for the home. When you do business with a person you know and trust, you can feel at ease knowing they aren’t leaving something out of the disclosure or inflating the price of the property beyond what it's worth.

You May Not Need A Real Estate Agent

The seller may not need a real estate agent to list the home, estimate a purchase price, show the house or negotiate the deal. You’ll likely save money on closing costs and the down payment because you and the seller won’t need to pay an agent’s commission.

You'll Have More Flexibility

In a typical real estate transaction, the buyer and seller are strangers. Coordinating times to meet can be more challenging because you’re not familiar with each other’s schedules.

And because there is less insight into the seller’s situation, a buyer in an arm’s length transaction may be less willing to accommodate a seller’s request to stay in their home longer. Family or friends may be a little more sympathetic and give the seller the extra time they need.

If you’re buying a home from a relative, you may even be able to live in the home with them until they move out.

You May Receive A Gift Of Equity

Your relative can’t offer a lower home sales price than they would a stranger (more on that later), but they can offer a gift of equity.

When a seller provides a gift of equity, they are agreeing to take a lower amount of net proceeds from the sale of the home, giving the buyer some of their equity. The lender accepts the gift of equity as a down payment, which reduces the loan amount.

If you get a gift of equity, you may not have to save for a down payment. And if the gift of equity is more than 20% of the home’s purchase price, you may avoid paying private mortgage insurance (PMI).

• There are a few eligibility requirements for a gift of equity:
• The home must be appraised to determine its fair market value.
• The seller must have sufficient equity in the home.
• The proper paperwork must be completed.
• The gift must be noted on a gift letter.

How The Gift Of Equity Works

Let’s say Jordan (our fictional buyer) is in the market to buy a home, and their parents have said they want to sell them their home at a discounted price. The home is worth around $300,000 and Jordan’s parents want to net $225,000 from the sale. While they can't give Jordan a discount on the purchase price, they can provide a gift of equity for $75,000.

No money changes hands, and the lender accepts the $75,000 gift of equity as Jordan’s down payment. Because the gift of equity is well over 20% of the purchase price, Jordan won’t need to pay PMI.

While the purchase price was $300,000, Jordan technically purchased it for around $225,000. Jordan didn’t have to borrow as much money from their lender, and Jordan’s parents received the net proceeds they hoped for while providing Jordan with financial support..

Drawbacks Of Buying A House From A Family Member

Given the challenges often involved with buying a home, it’s tempting to think that purchasing from family could be the better option, a win-win for both parties. But mixing business with family can be risky and present drawbacks.

Family Members May Take Advantage Of You

One of the assumed benefits of buying a home from a relative is that they won’t take advantage of you. But that’s not always the case. Your relative could take advantage of your trust and inflate the price of the home to get more money. Or that gift of equity to help you purchase the home suddenly becomes a loan you’re expected to pay back because their financial situation has changed, and they’re in need of money.

The Deal May Create Family Drama

The benefit of purchasing a home from someone you don’t know is that you typically don’t have to deal with them after the sale. If your loved one takes advantage of you during the sale or something happens to the home after you move in, the relationship could suffer. The seller could even have a hard time letting go of the home after they move out – constantly offering unsolicited input on how you should live in the home or feeling bitter over any changes you make in the home.

Family members who weren’t involved in the deal may be a source of drama. If there were other relatives who wanted the home, they may feel jealous or resentful toward you and the seller.

Non-Arm's Length Transactions Have More Restrictions

The potential for mortgage fraud increases when a real estate transaction is between two parties who know each other. Because of this, lenders take extra precautions with a non-arm’s length sale. They do this to protect themselves and the parties involved from fraudulent activities like misrepresentation, inflated prices and straw buyers.

One standard lenders apply to avoid fraudulent activity is the arm’s length principle of transfer pricing. The principle requires the sales price of the home to be the same no matter who the buyer is – a relative or a stranger.

If you have a personal or professional relationship with the seller, you likely can’t purchase a short-sale property.

With a short sale, most lenders require the buyer and seller to sign an arm’s length affidavit stating that no party in the short sale transaction is related or a business affiliate. It also states that there are no hidden agreements between the parties, and the sellers won’t try to regain title after the purchase is complete.

There May Be Tax Implications

If your family member provides a gift of equity that’s more than $17,000 for an individual donor or $34,000 for married donors, they will need to report it to the IRS and may need to pay taxes on the gift.

There may be other tax implications, like capital gains tax. We recommend speaking to a financial advisor or tax attorney to learn more.

Tips For Buying A House From A Family Member

You know the pros, the cons and the process of buying a home from a family member. Use these tips to help your transaction go smoothly.

• Have open discussions about the sale that communicate what you and the seller expect. Determine whether there will be a gift of equity and who will be responsible for any required repairs.
• Have the seller outline average utility costs, taxes or any homeowners association fees so you’re better prepared to handle the costs of homeownership.
• Consider working with a real estate agent, REALTOR®, lawyer and financial advisor.
• Don’t skip the inspection. There may be problems in the home the seller doesn’t know about.
• Have a title company handle the purchase so you can confirm there are no liens on the home.
• Make sure you understand the process and terms of the purchase agreement before signing anything.
• Purchase the home as your primary residence. Some lenders may not underwrite a mortgage for a second home or investment property if the seller and buyer have a business affiliation or family relationship. This rule may vary by state.

FAQs: Buying A House From A Family Member

Here are some questions people often ask about real estate transactions between family members.

What is it called when you buy a house from a family member?

When you buy real estate from a family member, a friend or a business partner, it’s called a non-arm's length or arm-in-arm transaction. If you’re financing your non-arm’s length purchase with a Federal Housing Administration (FHA) loan, it’s called an “identity of interest transaction.”

Can I buy my parents' house for $1?

There are rules to prevent extremely unbalanced home sales. You can buy your parents’ home at significant savings, though, through a gift of equity. There are Internal Revenue Service (IRS) limits about how much of a gift of equity your parents or other relatives can give you.

Is it smart to buy a house with a family member?

There are significant advantages to buying a family member's home. To name a few, you likely know the home, you may receive a gift of equity to apply to your down payment and you may not need to work with a real estate agent. On the flip side, there's also the possibility of stirring up family drama or being taken advantage of.

Can I buy a house from my parents without a mortgage?

If you can pay for your parents’ home with cash, you won't need a mortgage to buy the home.

What is a non-arm's length transaction on a mortgage loan?

Most real estate transactions are arm's length transactions. The parties involved have no previous relationship. A non-arm's length transaction happens when the buyer and seller have a personal or business relationship. While non-arm's length transactions are legal, lenders will likely add extra layers of scrutiny to prevent fraud.

The Bottom Line: Take Precautions When Buying A House From A Family Member

Buying a relative's home may help you get a lower price on a home or help you acquire a property you know and love. Make sure you’re working with the right experts to help you set the terms of the deal.

To learn more about the process or to get started, visit Rocket Mortgage® online or call (800) 785-4788.