An alternative to purchasing a house onn the open market is to purchase family-owned property. Buying a family-owned home allows the buyer and the seller to directly set the purchase price between themselves.
How The Transaction Is Set Up
In a family buy out, relationship between parties doesn’t matter (as long as clearly explained and logical), emphasis is placed on how the transaction is structured for loan purpose. Following are variations of how the transaction come play out depending on down payment, and availability of funds for procuring the property.
If seller has no mortgage (lien) on the property
New mortgage-$320,000, (represents 80% loan to value mortgage)
Gift of equity- $80,000
Seller- net is less $80,000 plus any applicable pro-ration of property taxes
Buyer purchases the property and pays the closing costs of approximately $8000.
If buyer has no money for use in the transaction
New mortgage taken out by buyer-$320,000 (represents 80% loan to value mortgage)
Gift of equity- $88,000 ($80,000 for the down payment, and additional $8,000 for the closing costs)
Seller- net is less $88,000 plus any applicable proration of property taxes, put another way, seller gives up the additional $8000 in closing costs for the benefit of the buyer
Buyer purchases the property without bringing any funds to the table.
If the seller has a mortgage (lien) on the property….
Seller mortgage loan payoff- $125,000
New mortgage taken out by buyer-$320,000, (represents 80% loan to value mortgage)
Gift of equity- $88,000 ($80,000 for the down payment, and additional $8000 for the closing costs)
Seller- net is less $88,000 less plus any applicable proration of property taxes as well as the $125,000 it took for paying off the mortgage
Buyer purchases the property and still does not bring any funds to the table despite the seller’s mortgage being paid off in full.
What to remember when buying a home from family or another party
If mortgage financing is being used on the side of the buyer, the lender is going to view the transaction as a non-arm’s length. Non-arm’s length is a traditional sale between the buyer and seller with there is no relationship between the two parties. A family property transfer is an arms length transaction because there is a relationship between the buyer and seller.
Mortgage lender will require:
- purchase contract between the buyer and the seller for the purposes of ordering an appraisal-loan is made against purchase price or appraised value, the lower of the two
- motivation letter from the seller explaining clearly explaining intention to sell the property to to a family member rather than on the open market
- the bigger the loan the buyer takes to purchase the property, the larger amount of net proceeds are available for the benefit of the seller less any liens on title to the property such as loans/debt
- the smaller the loan the buyer takes to purchase the property, the less amount of net proceeds are available for the benefit of the seller, buyer benefits with lower mortgage amount, subsequent lower monthly payment
- less than 20% equity using conventional financing will require a minimum down payment of 5% contribution from the buyer, using an FHA loan will require no minimum down payment from buyer, seller can full gift down payment