Things To Know When Buying A House From Family
When family or friends are involved, some requirements for non-arm’s length transactions are put into place to protect each person involved. Other requirements protect the lender and sometimes, there are emotional aspects to consider.
Restrictions Increase
Buying a house in a non-arm’s length transaction can create additional requirements to fulfill when you take out a mortgage. For example, a mortgage lender may require the seller to verify that they are not delinquent on the existing mortgage. Another restriction could be that you might be required to put down a specific down payment amount, depending on your lender or loan type.
For a non-arm’s length transaction with an FHA loan, your down payment must be equal to at least 15% of the purchase price. There are a few exceptions to this rule that allow your down payment to be 3.5%. They are as follows:
- You’re purchasing the primary residence of a relative, fiancé or domestic partner.
- You’re the employee of a builder purchasing one of the builder’s new homes to be your primary residence.
- You’re purchasing a property from a landlord or a family member that you’ve rented for the last 6 months prior to the purchase agreement.
Although this covers FHA loans, other loans may have restrictions. For more information, speak with a Home Loan Expert.
There Could Be Tax Implications
If you’re buying a house from a family member who wants to give you a gift of equity, more taxes may be involved. Under current Internal Revenue Service laws, an individual can give an equity gift of $18,000 each year or $36,000 for a married couple.
After that, it becomes taxable income for the seller. If you buy the house inexpensively and sell it within a few years, you could also be on the hook for capital gains taxes as a buyer. Check with an accountant or tax preparer to find out what your potential tax liability may be.
It Could Cause Family Strife
Not every transaction will alter family dynamics, but some will. Buying a home can be an emotional process, and this can be compounded by transacting with a friend or family member. Be careful when buying a house from a family member if it might jeopardize your relationship or if other family members might have strong feelings. It’s good to be aware that emotions can run high, so it’s wise to treat the home purchase as a business transaction.
It’s Not Over Until It’s Over
Family members may want to help each other out, but good intentions can sometimes be just that. If there’s a shift in the seller’s financial situation, they could be forced to raise the price, or have to try to get more competitive offers instead of selling the house to you.
Cheaper Closing Costs
One perk of buying a house from a family member is that closing costs will likely be lower. You also won’t need a real estate agent, which can save as much as 6% in commission. There also might be less need for an inspection of the home if you trust the family member you’re purchasing from. It can also make your closing date more flexible. Instead of trying to get two strangers coordinated, it may be easier for both parties to schedule closing and moving dates.
Buying A House From A Family Member: How It Works
Here are the steps you need to complete if you’re buying a home from a family member.
1. Get Preapproved
Get started with the approval process for a mortgagehere. During this process, your lender will verify your credit score, debt-to-income ratio (DTI), income and assets and the down payment you plan to make. You’ll receive a preapproval letter that will tell you how much they’re willing to lend you.
2. Determine The Purchase Price
To do this, determine the fair market value so your family member can price your home accurately. If there’s a gift involved, determine if your family member is giving you equity, paying closing costs or giving a cash gift. There may be tax implications for both the buyer and seller. Check with a tax professional for more information.
Real estate agents have tools to determine how a home should be priced. They review comparative market analysis, or comps, to gauge what homes are selling for in the neighborhood. From there, they come up with an estimate.
When you go into it alone, it’s up to you to figure it out. You can consider hiring an appraiser to complete a full home appraisal to determine the house's fair market value. This can be difficult if the property is located in a rural area or is unique in some way.
3. Draw Up A Purchase Agreement
The purchase agreement – also called the sales contract – should lay out all aspects of the transaction. This should include the price and any contingencies – like the home inspection, financing or appraisal contract opt-outs. With this contract in hand, you can contact your lender and officially apply for your mortgage. This is also a good time to verify that your family member is current on their mortgage payments since lenders could reject your application if they aren’t.
4. Complete A Title Search
Even if you trust your relative, it’s a good idea to hire a title company to protect you from any liens or to search for anyone else who may have a claim to the title of the home. Your lender will require a title insurance policy for its benefit, and you should consider purchasing one for your own benefit as well.
5. Consult An Attorney
A home is likely the biggest investment you make in your life, and you want to make sure you get it right. An experienced real estate attorney can help you with contracts and make sure you don’t make any costly mistakes. Buying from a family member or friend might lend an added sense of security. However, it can also make the transaction more complicated.
6. Continue Through Underwriting
During preapproval, your lender focuses on your creditworthiness. Once you’ve selected a property to buy, the focus shifts to the value of the home and whether it will cover the lender’s costs if you default on the mortgage. During this stage, your relationship with the seller and the terms of the transaction are closely scrutinized to make sure there is no fraud or undue influence.
During this time, it’s important not to engage in any activities that could impact your credit utilization ratio. Do not open new credit card accounts or make large purchases on your current credit cards. Even though you’ve been preapproved, lenders will run a last-minute credit check to make sure nothing has changed since the preapproval process.
7. Close On Your Home
At closing, the title will be transferred and you’ll be given the keys to your new home. Closing a non-arm's length transaction doesn’t always mean you’re at the end of the process. It’s good to be aware that if the IRS chooses to, it can take a hard look at any non-arm’s length transaction at any time.
This is so they can make sure it was conducted correctly and that there was no improper motive behind the sale. Having a tax professional or real estate attorney who specializes in these types of transactions on board can help ensure that if the IRS looks at your transaction, everything is handled properly.
