How to buy a house from a family member
Key takeaways
- Unlike a traditional home purchase, buying from a relative is a non-arm’s length transaction, meaning the buyer and seller have a pre-existing relationship.
- As such, it may receive additional scrutiny from mortgage lenders and has the potential to cause family tension.
- In such transactions, it’s smart to have a real estate lawyer draw up a thorough contract, so that all terms are clear and there can be no misunderstandings.
Eager to purchase a home but worried about the housing market’s high prices, mortgage interest rates, competition from other buyers and the legwork involved with finding the right property? Many of these challenges can be simplified if you have the opportunity to buy directly from a relative, whether that be an aging parent, a sibling who’s moving away from your hometown or any number of other circumstances. Here’s what to know about how to buy a house from a family member.
Who should consider buying a house from family?
The best candidates for buying a home from a relative are those who plan to occupy the property as a primary residence. “Standard conventional mortgage guidelines will not allow a buyer to purchase the subject property as a second home or investment property if there is a family or business relationship with the seller,” says Robert Killinger, a senior loan officer with Movement Mortgage in Danvers, Massachusetts.
An adult child who may not have enough saved for a down payment on a home could also be a good candidate. “In this scenario, the family member selling the home may be willing to issue a gift of equity, which in turn allows the buyer to get into the property with little to no down payment,” Killinger says. Additionally, parents who choose to sell to one of their adult children are spared the hassle of listing and showing their home.
The ideal scenario would be buying from a family member with whom you have a good relationship, and who is willing to sell at a fair price, says Matt Teifke, broker and co-owner of Teifke Real Estate in Austin, Texas.
Pros of buying a family member’s home
- Commission savings: If you and a trusted family member agree to a sale, you might be able to eliminate the need for real estate agents. Considering that the typical agent commission is 2.5 to 3 percent of a home’s sale price, this can equate to substantial savings: If you agree to purchase the home for $300,000, for example, each of you stand to save up to $9,000.
- Potentially lower price: Teifke says your relative may accept a lower price on the home “since you are cutting out the real estate agent’s commission” — and, of course, since you’re family.
- No need to house-hunt: Buying a home from kin means you don’t have to waste time shopping around and touring homes for sale. And, assuming you are already familiar with the property (perhaps you even grew up there), chances are you already like the layout and features.
- Less need for due diligence: You may have some extra peace of mind that the home is well-maintained, too. “If you have a good relationship with the family member, you can trust them to be honest with you about the condition of the property,” says Teifke. If you are confident in its condition, you might even be able to skip a professional home inspection and save on that cost as well.
Cons of buying a family member’s home
On the other hand, putting too much trust in a handshake deal with a family member can backfire. The major disadvantage of a financial deal of this size with relatives is that it can cause seriously bad blood.
“If you don’t take precautions, like creating a carefully worded contract, you may create tension and issues,” says Dennis Shirshikov, head of growth at real estate website Summer and an adjunct professor at the City University of New York. “Protect yourself and your family members by putting everything in writing and getting an attorney to review it.”
Any issues there are with the house can also become heightened when family is involved. “One of the things I often see happen is a major system, such as the air conditioning, plumbing, electrical or roof, fails after closing,” says Kristen Conti, broker/owner of Peacock Premier Properties in Englewood, Florida. “Buyers often feel the seller — even if they are a family member — sold them something defective. This can create major rifts within families if someone feels slighted.”
How to buy a house from a family member: 5 key steps
The core process of purchasing a home from a relative is not so different from a traditional sale. Here are five basic steps to follow.
- Figure out your financing: Get preapproved for a mortgage first, before discussing purchasing the property. Or, consult an attorney about drawing up an owner-financing arrangement, in which your family member will finance your purchase rather than a bank or other lender.
- Agree on a price: Determine whether the sale will be for fair market value or if there will be any gifts in play, such as a down payment gift, cash gift or credits to cover closing fees. “Any gifted funds will have to be documented via a gift letter and adhere to the mortgage lender’s underwriting guidelines,” says Killinger.
- Create a contract: Your real estate agent or attorney can draft a formal purchase and sales agreement. This document should outline all the key details and terms of the deal, including the sale price, any contingencies and who is responsible for paying specific fees and commissions.
- Secure a mortgage: Apply for and secure official financing as needed, keeping in mind that mortgage lenders are likely to require a title search and a home appraisal, both of which will incur a fee. If you choose to have the home professionally inspected, now’s the time to schedule that as well.
- Close: Closing is the final step in becoming the property’s new owner. There will be closing costs to pay and a lot of paperwork to complete, which your agent can help you with. Many states require an attorney to oversee real estate closings, so if this is the case in your state, be sure to work out in advance who will hire them and who will pay the legal fees.
Non-arm’s length transactions
A non-arm’s length transaction is one in which the seller and buyer have a pre-existing relationship, whether it’s business-related or personal. This is different from the typical arm’s length transaction, in which both parties are strangers who each act separately to achieve the best deal possible — and it can make things tricky.
“When people involved in a major transaction like a home purchase have shared interests, there is an increased risk of fraud,” says Martin Orefice, CEO of real estate site Rent To Own Labs. “Fraud can result either via the two parties cooperating to sell the property for an artificially low price, or through one of the two parties in the transaction taking advantage of the other.”
Consequently, some lenders will not offer mortgages for this type of deal, while some subject them to increased underwriting scrutiny. It’s also a good reason to hire an attorney, even if you don’t plan to use a real estate agent for the transaction.
Consider that tax laws also apply to these transactions. The IRS may scrutinize the sale price of a non-arm’s length deal to determine if it meets fair market value or is regarded as a gift. “The closer the home is priced to its real market value, the less tax trouble will result,” Orefice says. “If you purchase the house for less than its market value, you will have to claim a gift of equity on your taxes.”
Do’s and don’ts of buying a house from family
Do
- Be fully committed: “Make sure you’re 100 percent set on the property in question,” says Killinger. “Emotions can run high when it comes to family property, and the buyer should make sure they are all-in on the purchase.”
- Get everything in writing: “It’s important to have a written purchase agreement that includes all the details of the transaction,” says Teifke. “This will help to protect both you and your family member in case there are any later disputes.”
- Have the deal vetted by outsiders: It’s natural to want to save money, but paying for basic guidance from experts, like real estate attorneys, Realtors and tax experts, can save you a lot of hassle — and family drama — in the long run.
Don’t
- Agree to anything without a financing plan: “It’s important to make sure you can actually afford the home before agreeing to purchase it,” Teifke says.
- Accept terms that are not in your best interest: Just because you’re dealing with family doesn’t mean you shouldn’t look out for yourself. For example, be sure to get a home appraisal so you have a professional, impartial evaluation of the home’s worth. “Even if this is an all-cash purchase, pay for an appraisal to ensure the value is fair to all parties,” says Conti.
- Skimp on the details: Real estate deals are complex, whether the buyer and seller are related or not. That’s why it can be smart to hire an agent or a lawyer even if you don’t feel like you need one. They know exactly what needs to be done to close successfully — including filing the right paperwork, completing the required legal disclosures and transferring the title and deed correctly — so that you don’t have to.
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