Eager to buy a home but worried about mortgage interest rates, competition from other buyers, and the legwork involved in finding the right property? Many of these challenges are made easier if you can purchase a residence from a relative.
Take the time to learn the pros and cons of buying from a relative, what’s involved in buying a home from a relative, non-compete mortgage issues, and more.
Good candidates to buy a house from a family member
The best prospects for buying a home from a relative are those who plan to occupy the property as their primary residence.
“That’s because 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, senior loan officer at Mortgage Network.
Another candidate is an adult child who may not have enough saved for a down payment on a house.
“In this scenario, the family member selling the home may be willing to provide an equity gift, which in turn allows the buyer to move into the property with little or no down payment,” explains Killinger.
Another popular scenario is when parents are downsizing and planning to move for retirement.
“They could sell their family home to one of their adult children,” says Martin Orefice, CEO of Rent To Own Labs. Doing so means parents can avoid the hassle of listing and showing their home.
Ideally, the best arrangement is when you have a good relationship with the family member looking to sell their home, are willing to sell the property for a fair price, and can get a mortgage from a bank or other lender if you need financing. , according to Matt Teifke, founder/CEO of Teifke Real Estate.
Pros and cons of buying a relative’s house
There are several benefits and risks to buying a home from a relative. Weigh these pros and cons carefully before committing to the transaction.
What are the advantages?
For starters, if you and a family member agree to a sale and are on good terms, you can eliminate the need for a real estate agent and pursue an owner-sale transaction. Considering the average real estate commission is 5% to 6% of a home’s sales price, this can equate to substantial savings. Case in point: If you agree to buy the house for $300,000, you’ll likely save at least $15,000 that would otherwise be paid in commissions.
Teifke says his relative can accept a lower price for the house “because he’s cutting the realtor’s commission.”
Plus, claiming a house from relatives means you don’t have to spend time shopping around and touring houses for sale. And assuming you’re already familiar with your relative’s home (perhaps you grew up in the abode or visit it regularly), chances are you already like the design and layout and have peace of mind knowing the home is well-maintained.
“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,” adds Teifke.
If you need to borrow funds to complete the transaction, you may even be able to eliminate the need for a home loan if your relative provides owner financing.
Plus, if you trust your relative and are sure of the property’s condition, you can skip a professional inspection and save on those costs too.
What are the disadvantages of buying from family?
On the other hand, relying too heavily on a handshake with a family member can backfire.
“If you don’t take precautions like creating a carefully drafted real estate contract, you can create tension and problems. You should protect yourself and your family members by putting everything in writing and getting it reviewed by an attorney,” says Dennis Shirshikov, strategist at Awning.com and professor of economics and finance at the City University of New York.
Kristen Conti, broker/owner of Peacock Premier Properties in Englewood, Fla., says she has seen many problems arise when families buy each other’s homes.
“This can create major divisions within families if someone else in the family feels slighted. One of the things I often see happen is that a major system, such as the air conditioning, plumbing, electrical, or roof, fails after closing. Buyers often feel like the seller, even if it’s a family member, sold them something faulty and will expect them to pay for it or fix it,” she says. “Often, putting your home up for sale on the open market results in a higher selling price and avoids conflicts that can tear families apart.”
Understanding Non-Arm’s Length Transactions
A non-arm’s length transaction is one in which both parties involved have a personal or financial relationship. This is different from the more common arm’s length transaction, in which the seller and buyer are strangers acting separately in their own interest to achieve the best possible deal.
“When the people involved in a major transaction like buying a home have shared interests, there is a higher risk of fraud,” says Orefice. “Fraud can result either through the cooperation of the two parties to sell the property at an artificially low price, or through one of the two parties to the transaction taking advantage of the other.”
That’s why hiring an attorney is best, even if you don’t plan to use a real estate agent for this sale.
Please note that tax laws also apply to non-arm’s length transactions. The IRS will look at the sale price of a non-arm’s length transaction to determine if it meets fair market value or is considered a gift. The IRS can flag you for trying to avoid capital gains tax if you don’t follow its rules, including IRS gift laws if the property is sold for less than its fair market value.
“The closer the price of the house is to its real market value, the less tax problems will result. If you choose to buy the house for less than its market value, you will have to claim an equity gift on your taxes. This is essentially a tax on the value of the home that you got by paying less than the market price,” says Orefice.
Under current IRS rules, your relative can provide a capital gift of $15,000 each year or $30,000 for a married couple. Beyond those limits, it becomes taxable income for the seller.
How does it work to buy a family house?
The process of buying a house from a relative is quite simple. But it is imperative not to take shortcuts. Experts recommend taking the following steps:
- Get pre-approved for mortgage financing before discussing the purchase of a family member’s property. Or discuss an owner financing agreement where the seller provides you with partial or full financing directly after you make a down payment. In most owner financing agreements, you make mortgage payments to the seller on an agreed-upon amortization schedule at a specified fixed interest rate. Often the seller only holds the mortgage for up to 10 years, after which the remaining balance is due in the form of a balloon payment. An experienced attorney can help you work out the details.
- Agree on a price for the house. Determine if the seller will sell at fair market value or if there will be gifts at stake, such as a down payment gift, cash gift, or credits to cover closing fees. “Keep in mind that donated funds will need to be documented through a gift letter and meet the mortgage lender’s underwriting guidelines,” adds Killinger.
- Create a formal purchase and sale agreement with the help of an attorney or real estate agent. The buyer and seller should each have their own attorney representing their respective interests, advises Killinger. Additionally, the purchase agreement should “outline the terms of the sale, including the sale price, any contingencies, who is responsible for paying any outstanding mortgages or liens on the property, and more,” says Jennifer Spinelli, founder and CEO of Watson Buys. .
- Opt for a title search, home appraisal and professional home inspection for added peace of mind.
- Secure financing as needed to complete the transaction.
- Close to property.
Tips for buying a house for a relative
Also, be aware of the do’s and don’ts when trying to buy a home from a family member.
- Be fully invested and committed to the purchase. “Be 100 percent fixed on the property in question. Emotions can run high when it comes to a family property, and the buyer needs to make sure they have their full stake in the purchase,” says Killinger.
- Get everything in writing. “It is important to have a written purchase agreement that includes all the details of the transaction. This will help protect you and the family member in case there are any subsequent disputes,” says Teifke.
- Rely on experienced outside resources. It’s natural to want to save money, but don’t put that ahead of due diligence. Consider recruiting professionals such as an experienced attorney, real estate agent, certified public accountant, tax expert, title company, and professional inspector.
- Get an appraisal. “Even if it’s a cash purchase, pay an appraisal to make sure the value is fair to all parties,” Conti suggests.
- Double check the math. Make sure you’re not breaking IRS rules and tax laws. Have your real estate contract reviewed by an experienced attorney as well.
not to do
- Avoid agreeing to buy a home without first obtaining financing. “It’s important to make sure you can really afford the house before you agree to buy it,” says Teifke.
- Do not agree to terms that are not in your best interest.
- Do not close the sale without first making sure ownership of the property is transferred through a deed.