Most home sales are arm’s length transactions — deals between former strangers. But selling to a relative, colleague or friend can also make sense in certain circumstances.
When friends or family members transfer homes to each other, they have a few special questions to consider. Because every relationship and every home sale is unique, we cannot cover all situations. Nor can we provide legal advice to our readers. But we can spot some general issues sellers and buyers should know. Let’s dive in!
Good Deals With Friends: When a “Non-Arm’s Length Transaction” Goes Well
What’s gained when you’re selling to someone close to you? A closing date should be easy to set up between people who know each other. The process can be less formal.
By pulling up one of the online real estate sites, you can check the rough value of your house, based on comparable recent sales. The seller can offer the buyer a break on the home price by offering what’s called a gift of equity. If you’re selling your home to your friend, colleague, or relative and want to let it go at a price lower than market value, this is one way to do it. The difference between what the buyer pays and the actual market value is the gift. A lender might allow the buyer to put this amount into the down payment, or use it for closing costs generally. A mortgage specialist can explain how the gift of equity affects the terms of a loan.
To proceed with this arrangement, you as the seller need a current appraisal. The lender will require gift equity paperwork showing the gift amount. Both seller and buyer will sign off on the gift; and the gift will be documented with a settlement letter at the closing table.
Too Close for Comfort? Potential Pitfalls When the Seller Knows the Buyer
Non-arm’s length transactions aren’t always appropriate. They have to meet certain rules to be legally acceptable. When seller and buyer know each other, the lender will need to ensure that the deal is fair and properly structured. There are minimum down payments. Selling the house to someone you know for less than the total amount owed on the mortgage is not permitted. Failure to follow the rules is against the law.
But what counts as non-arm’s length? It depends on the lender’s guidelines, as they intersect with state law.
Law aside, plain old disappointments can happen. It’s not unusual to want to help out a friend or relative. But as a seller, take care not to overpromise. What if there’s a change in your circumstances, and you need to obtain fair market value for your home?
Think, too, about the condition of the home you’re passing along. Have the buyer bring in an independent home inspector. Fix any issues that crop up. Probably the last thing you want, as a well-meaning seller, is for things to start falling apart after the person you “helped” takes over the maintenance responsibility.
Along these lines, your buyer needs an emergency fund for all the necessary fixes. Freddie Mac urges homebuyers to be ready with as much as 4% of the property’s value in annual maintenance costs. Even for a modest condo valued at $150K, that’s $600 a month (in addition to taxes, insurance costs, the mortgage, utilities, water and sewer, waste collection, and possibly a homeowners’ association fee!). Be sure your buyer has a strong grasp on the full cost of keeping up the home.
Pro tip: Older homeowners must be aware of the five-year Medicaid lookback period. The federal government can look back to find out if the homeowner gave assets away during that period and disqualify the seller from Medicaid benefits, at least temporarily.
☛ Understand Medicaid benefits and recovery. Ask whether the Life Estate Deed Fits Into Your Estate Planning.
Ask a Local Attorney About Your Alternatives
A local real estate attorney can help you transfer your title to someone close to you. With an attorney who specializes in this area of state law, you can discuss the comparative pros and cons of a sale or a trust, and how everyone’s living arrangements can be structured in the meantime.
What else can an attorney discuss with you? Taxation.
☛ Brush up on capital gains taxes and gift exemptions. For Home Sellers: Capital Gains Tax 101.
You’ll be passing along your tax basis if the transfer is legally categorized as a gift. If the new homeowner could be selling the house within a few years, it’s important to consult with a lawyer or tax specialist regarding potential capital gains taxes. If instead you bequeath the house in your will to your family member, the recipient benefits from the stepped-up tax basis. Maybe an inheritance is the better option if you’ve seen a big rise in value over the time of your ownership.
There may be other, state-specific ways to reduce taxes associated with sales and loans. An attorney in the local real estate field will know these things. An attorney can also help you weigh the pros and cons of the various ways to transfer the deed. Given the parties’ financial situations, could it be better to sell the home on the market, then work out other arrangements to help the friend or relative? Alternatively, it might be worth considering an installment sale agreement, also known as a contract for deed.
☛ A contract for deed bypasses the immediate need for a mortgage approval. The seller plans to transfer the title later, and the buyer sends the seller monthly payments for now. See: For Home Buyers and Sellers: How a Contract for Deed Works at Deeds.com.
Check your state law to see if an attorney must, by law, handle your sale. In most states, you can draft a deed and convey it to somebody else without a lawyer.
In any case, many factors in a non-arm’s length transaction make an attorney’s advice important to consider. Have the buyer get a separate real estate attorney, if you have one.
How the Home Sale Process Works
When you’re ready to sell the house, you’ll create a purchase agreement to state the price and the terms of the transfer. A lawyer can help you and your buyer forge a contract that meets the requirements of the state where the real estate is.
The next step? Begin the loan application process. A mortgage expert will work with the buyer, collecting all necessary documentation including the gift of equity paperwork. The mortgage specialist will guide the borrower through the underwriter’s hoops, too. For the best interest rate opportunities, the buyer should have a good credit profile, a low debt-to-income ratio, and an ample down payment.
The buyer will need to obtain title insurance. Be sure the buyer understands the difference between a lender’s policy and an owner’s policy, and between a standard and extended policy.
☛ Read more from Deeds.com on Standard and Extended Title Insurance Policies.
The title company can give guidance the whole way — from hooking the buyer up with a mortgage pro, to handling the settlement documents, to recording the deed.
Who Needs a Real Estate Agent?
For Sale by Owner (FSBO) transactions can be guided by a real estate professional — or not. For a non-arm’s length home sale, the services of local attorneys may work out to be less pricey than the agents’ commissions. That said, agents offer some important advantages.
The knowledge and experience of a real estate agent can be helpful in pricing matters, and in dealing with appraisal and inspection reports. Some agents will handle the purchase agreement and offer guidance for a set fee for a non-arm’s length sale. Agents can offer the expertise it takes when sticky questions come up. They can guide negotiations. As in any other sale, agents provide the professional filter that helps the parties avoid awkwardness and stress.
If you decide to bypass agents, it’s a good idea to have an attorney representing each side. The main thing is to handle the transfer with the professionalism that goes into any home sale. It’s important that your deed meets your state’s legal criteria so it survives any possible challenges.
A Great Gift
Transferring a house title to someone you care about can be a wonderful thing to do. A head start in equity building is a great gift, especially in today’s uncertain economy. And there’s something special about a non-arm’s length transaction. The story of your personal connection with the buyer will always be part of the chain of title.
Rocket Mortgage: How to Buy From a Family Member (May 15,2021).
UpNest: What Is the Annual Cost of Maintaining a Home? (Feb. 12, 2021).
Photo credits: Kindel Media, via Pexels.