You may be keeping a cherished place within the family. You already know the house intimately, so no surprises. However, some drawbacks could complicate the process.
There are two categories in real estate transactions: arm's length and non-arm's length. Most people buy homes without knowing the seller personally or professionally. They're entirely acting in their self-interest. This is called an arm's length transaction. Essentially, when you purchase a home from a stranger. When the buyer and seller know each other, it's called a non-arm's length transaction. This type of relationship could be neighbors, co-workers, friends, and obviously, family.
When the buyer and seller know each other, they can better execute how the transaction would benefit them or possibly fraud. Perhaps they agree to deceive lenders so that they both end up profiting. The real estate market depends on the competition in arm's length transactions to coordinate prices. It craves the opposition of buyer and seller, supply and demand, or consumers and producers. In a non-arm's length transaction, one party may take advantage of another party. An unsuspecting family member may not question the price of a home from an untrustworthy relative. They often don't have a real estate agent working with them to tell them otherwise and then pay way more than the house's market value.
Government and individual lender guidelines must be followed as protection. Lenders must do an in-depth investigation when checking your finances as a way to protect themselves from any illegal activity.
In a short sale, the price of the property is less than the amount of the total mortgage owed. Therefore, an arm's-length affidavit may be required by the lender. This protects against fraud from the seller, who may give the property to a family member who resides in the home after a short sale, allowing for a much cheaper mortgage rate. The affidavit states that no existing or prior association exists between the buyer and seller, and any violation of that could cause civil and criminal liabilities for everyone involved.
There are already many requirements to fulfill when applying for a mortgage in an arm's length transaction. That said, you will have even more to do in a non-arm's length If you are an employee of a builder (cannot be family), and you're purchasing a primary residence that is one of the builder's new houses or models
Purchase of a primary residence of a family member OR property owned by family member AND borrower has leased it legally for 6 months. A seller may have to verify to the mortgage lender that they're not delinquent on the current mortgage, therefore, requiring you to put down a down payment. For instance, if you want an FHA loan in a non-arm's length affidavit, your down payment has to be 15% of the purchase price, at least. Some exceptions allow for a down payment to be 3.5 %.
More taxes may be involved if you are given a gift of equity. A gift of equity is when a family member or friend from which you're purchasing a home gives you a financial break. According to Internal Revenue Service laws, a family member can give up to $15,000/year to another family member or $30,000 for a married couple. Anything over that becomes taxable income for the seller. If you buy a house and then sell it a few years later for more, you, as the buyer, will be responsible for capital gains taxes as well. As always, it's best to contact an accountant or tax preparer to understand your potential tax liability.
Doing pretty much anything with family can trigger emotions, not to mention a real estate transaction. Take stock of your relationships and decide if it's worth putting them in potential jeopardy. It is sometimes better to handle a home purchase as a business transaction and nothing else.
In a perfect world, families would give each other anything they have without asking for a dime. While they may want to help one another out, money talks. Be prepared for the seller to raise the home price or open the sale to competitive offers.
Closing costs will most likely be lower when buying a home from family or, said, known persons. You can save as much as 6% in commission without working with a real estate agent. If you trust the homeowner or know the house well yourself, there is no need for a home inspection. There may even be less stress around scheduling the closing date as you have direct correspondence with family or friends.
As stated earlier, a gift of equity is when an immediate family member sells you their property below the current market value. Most often, this happens when the home price is less than the market price, making the difference the gift of equity. Most lenders will accept the gift of equity as a down payment. Here are a few requirements for a gift of equity:
Same as usual, one must get pre-approved. You will need your lender to verify your credit score, (DTI) debt-to-income, assets, down payment you plan to make, and income. Upon doing this, you will receive your pre-approval letter stating how much the lender will lend you.
For your family to price the home honestly, they will need to determine the fair market value. Factor in any gifts, i.e., a gift of equity, a cash gift, or covering closing costs. Check with a tax professional as taxes may be involved with all three gifts. Typically, comparative market analysis, or comps, are used by real estate agents to determine how a property is valued. However, when not using a real estate agent, you have to figure this out yourself. Getting the home appraised is an excellent way to determine the fair market value.
A purchase agreement (aka sales contract) details the transaction: price, contingencies, i.e., home inspections, appraisal contract opt-out). This contract allows you to apply for a loan officially. Make sure the seller is current on their mortgage, or that will significantly affect your chances of being pre-approved.
Hire a title company as protection against any liens or anyone else who may have a stake in the property. Although you're dealing with family and you trust them at their word, it's best to have experts around just in case.
Just because you are dealing with someone you know doesn't mean that things will go smoothly. Purchasing a property is an enormous undertaking, and it's best to have experts around you as protection when it comes to contracts and legal issues.
The pre-approval process demands an enormous amount of scrutiny from your lender. They're focusing on your every financial move, past and present. When you find the home you want to purchase, the focus shifts to the value of the property and whether you'll be able to cover the lender's costs if you default on the mortgage. The relationship between you and the seller is also focused on solidifying no fraud or other interests at play. Therefore, it's best not to do anything that would impact your credit. New credit card accounts, and big purchases on current credit cards are not advised during this time. Lenders are required to run credit checks even after they've approved you.
Upon closing, the title is handed over, and you will receive your keys. However, do not rest on your laurels as the IRS will always check up on a non-arm's length transaction. In fact, with a non-arm's length transaction, your finances will be explored much more keenly to protect from anyone acting out of self-interest.