Buying a home from someone you know—a parent, sibling, or close friend—can sound like the perfect deal. You may already be familiar with the house, the process might feel less intimidating, and you could even save money on certain costs. But these kinds of sales, known as non-arm’s length transactions, come with a few extra rules and potential challenges you’ll want to understand before moving forward.
This guide breaks down what a non-arm’s length transaction is, why lenders look at them differently, and the steps you can take to make sure the process goes smoothly.
What Is a Non-Arm’s Length Transaction?
A non-arm’s length transaction happens when the buyer and seller have a personal relationship. This could be a sale between:
- Parents and children
- Siblings
- Extended family members
- Friends
- Even co-workers
In a typical real estate deal, called an arm’s length transaction, the buyer and seller don’t know each other personally. Each side is acting purely in its own financial interest, which makes it easier for lenders to assume the sale price reflects the true market value.
When the buyer and seller already have a relationship, however, the motivations can be different. For example, a parent might sell their home to their child for less than its worth to help them out. While that can be a generous move, lenders and tax authorities need to make sure everything is above board.
Are Non-Arm’s Length Transactions Legal?
Yes, they are completely legal. But because there’s a higher risk of fraud or unintentional misrepresentation, they face more scrutiny from lenders, appraisers, and sometimes the IRS.
The concern is that people could take advantage of the relationship to commit mortgage fraud—for instance, by inflating the home’s value or hiding debts. To prevent this, lenders apply stricter rules and documentation requirements.
Why Lenders Care
Mortgage lenders have to make sure the loan is safe and that the property is worth what the buyer is paying. In a non-arm’s length transaction, lenders may require:
- Proof of ownership and payment history: The seller may need to confirm they’re up to date on their mortgage.
- Appraisals: Lenders will usually require a licensed appraiser to establish the fair market value.
- Minimum down payments: For FHA loans, the rules are stricter. Normally, FHA requires just 3.5% down. But in a non-arm’s length deal, you may need to put down 15%—unless you qualify for one of the exceptions (like buying your parent’s home as your primary residence).
Another example is the arm’s length affidavit sometimes used in short sales. This document states that the buyer and seller have no hidden ties or agreements that could affect the fairness of the transaction.
Key Things to Know When Buying a Home from Family
- Increased Restrictions – Expect extra conditions from your lender. Some mortgage types have specific rules about down payments, paperwork, and seller eligibility.
- Tax Implications – If a family member sells you the house for less than its market value, the difference is considered a gift of equity. For tax purposes, the IRS allows an individual to give up to $18,000 per year (or $36,000 for married couples) without triggering gift taxes. Anything above that amount may count as taxable income for the seller. Additionally, if you later sell the home, capital gains taxes could apply depending on how much the value has increased.
- Family Dynamics – Money and family can be a tricky mix. Even with the best intentions, disagreements may arise—about price, repairs, or expectations. Treat the deal like a business transaction to help avoid emotional fallout.
- Lower Closing Costs – One big upside is potential savings. If no real estate agent is involved, you can avoid paying up to 6% in commissions. Plus, since you and the seller already know each other, you may have more flexibility with timing and negotiations.
What Is a Gift of Equity?
A gift of equity happens when a seller (usually a family member) sells their home for less than the fair market value, and the difference is considered a “gift.”
For example:
- Fair market value: $300,000
- Sale price to child: $250,000
- $50,000 difference = gift of equity
This gift can often be applied toward the down payment, which can be a huge help for buyers who don’t have a lot of cash saved up. However, it must be properly documented with:
- A professional appraisal
- A gift of equity letter
- Disclosure on the settlement statement at closing
Steps to Buying a House from a Family Member
Here’s what the process typically looks like:
- Get Preapproved – Before you agree on a price, find out how much you can borrow. A lender will check your credit, income, and debts.
- Establish the Purchase Price – Work with an appraiser or real estate professional to determine the fair market value of the home.
- Create a Purchase Agreement – Put everything in writing, including the price, contingencies, and any special arrangements.
- Run a Title Search – Make sure the property doesn’t have unpaid liens, disputes, or claims that could complicate the sale.
- Consult an Attorney – A real estate attorney can help ensure the paperwork protects both sides.
- Go Through Underwriting – Your lender will carefully review the transaction to ensure it meets all guidelines.
- Close the Sale – Finalize the paperwork, transfer the title, and get the keys to your new home.
Final Thoughts
Buying a house from a family member or friend can be a smart and meaningful decision—whether it’s keeping a cherished home in the family, getting a financial break, or simply enjoying a smoother transaction. Just remember: while the process may feel informal, lenders and tax authorities will treat it with extra scrutiny.
By understanding the rules around non-arm’s length transactions and preparing the right documentation, you can avoid headaches and keep the experience positive for everyone involved.
If you’re considering buying a home this way, O1NE Mortgage can guide you through every step. Visit O1ne Mortgage Inc. or call (866) 688-9020 to explore your options and start your mortgage application today.
