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How To Buy Your Parent’s Home
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Trying to find the perfect home can be a stressful and expensive process, so you may consider buying a property you’re well-acquainted with — your parent’s house.
7 steps to buying your parent’s home
While there are benefits to buying your parent’s home, there are also potential pitfalls to mixing family and finances and steps you should take to make sure everyone feels like they are being treated fairly.
Step #1: Negotiate a price to buy your parent’s home
Technically, a home is worth what a buyer and seller agree to in writing. However, what’s “fair” can often be subjective. A child may hope to buy the home at a lower price than the house would fetch on the open market. However, your parents might want to sell at market value because they need the money to retire. You may be able to find a middle ground that meets both your needs if you:
- Get a comparative market analysis (CMA). A real estate agent can access local databases of sold homes to give you an idea of how much your parent’s home would be worth if it was sold to a stranger.
- Try online valuation tools. An online home value estimator may give you a general idea of home sales, although the data may not be as precise as a CMA.
- Get a home appraisal. A home appraisal is a report that a licensed real estate appraiser generates to give you an unbiased opinion of your home’s value based on a deep-dive comparison of the home’s features to other sold homes in your area. One note: If you need a mortgage to buy the home, the lender will probably require an appraisal for the loan approval.
THINGS TO KNOW
It’s always a good idea to get a home inspection on any house purchase so you know about any unseen issues. The purpose of a home inspection is to give you a detailed look at all the working parts of the house. If your parents are elderly or disabled, they may not have performed ongoing maintenance, making it even more important for you to know what’s going on from the foundation of the house up to the rooftop.
Step #2: Decide whether you’ll be legally represented
Your parents may avoid the cost of a real estate agent commission by not hiring a real estate agent to sell their home to you. However, that means you may be missing out on the guidance a real estate professional can offer to properly prepare paperwork and understand the legal implications if things go wrong.
If you forego a real estate agent, it may be worth it to at least have a real estate attorney review the purchase agreements before everyone signs. You may also need to consult with a tax professional if your parents are gifting you equity or money for a down payment.
Step #3: Sign a written agreement to buy your parent’s home
When it comes to real estate, even a sale between you and your parents has to be in writing to be legally binding. Here’s what you’ll need to do to make that happen:
- Have a real estate agent prepare a purchase contract. A licensed real estate agent has the experience to negotiate contracts based on the laws of your state and can help you navigate who should pay which fees. They typically have a good handle on how much houses are selling for, so they can help you negotiate a price based on current data.
- Have an escrow officer or attorney prepare “escrow instructions.” If you don’t hire a real estate agent, you should still have escrow instructions. This written directive includes details about the price, who will pay which closing costs and whether the purchase involves you getting a mortgage or a gift from your parents for the down payment.
An escrow officer or attorney specializing in real estate may be able to help you prepare the documents for a fee. They are also a neutral third party that handles all the accounting of money that flows through the transaction.
In general, the purchase agreement should include:
- The price of the home
- The names of the buyers and sellers
- Who will pay what closing costs
- Anything that will stay or go with the property (such as personal property, fixtures and built-in shelves)
- The closing date
THINGS TO KNOW
Make sure you don’t skimp on the cost of title insurance — it could protect you against judgments or liens that jeopardize your ownership of the home. Typically, the seller pays for an owner’s policy and the buyer pays for a lender’s policy (if you’re taking out a mortgage). Even if you have to pay for both policies, the cost is well worth it to cover any unknown claims against the home.
Step #4: Document any gifts of equity for buying your parent’s home
In many cases, a parent will choose a gift of equity to help their child avoid a down payment for a home purchase. No cash actually changes hands — the parents simply gift a dollar amount of the equity toward the down payment. The rules for a gift of equity work differently than regular cash down-payment gift rules. You may want to review these rules if a gift of equity is part of your plan to buy your parent’s house.
FHA gift of equity rules
Loans backed by the Federal Housing Administration (FHA) are popular for first-time homebuyers because of their flexible qualifying standards compared with those of conventional loans. You may be approved with a credit score as low as 500 with a 10% down payment, or 580 with a minimum 3.5% down payment. FHA loans may also be approved even if you have more debt than your income (known as your “debt-to-income” or “DTI” ratio) than conventional loans allow.
To get a gift of equity for just the minimum down payment of 3.5%, you’ll have to meet one of the following conditions:
- Prove the home was your parent’s primary residence
- Prove you were living in the home as your primary residence as a tenant with a copy of the lease and documentation of six months’ worth of rent payments
If you can’t meet the above requirements, then the following gift of equity requirements apply:
- You’ll need a 15% gift of equity
- You have to provide a gift letter confirming the equity is a gift and no repayment is expected
Conventional Fannie Mae gift of equity rules
Fannie Mae is one of two government-sponsored enterprises (GSEs) that purchase mortgages for residential homes, allowing lenders to offer mortgage programs with down payments as low as 3%. Conforming conventional loans require a minimum credit score of 620 and a lower DTI than FHA loans in most cases.
Fannie Mae requirements for a gift of equity are as follows:
- You can receive a gift of equity for all or part of the down payment for a primary residence
- You don’t need to contribute any of your own funds
- You must provide a completed gift letter signed by you and your parents confirming no repayment is expected
- The closing statement must also show the gift of equity was given
Freddie Mac is the other GSE, but the rules for a gift of equity are slightly different if you’re buying your parent’s home as a second home:
- You must provide and document 5% of the sales price from your own funds if the down payment is less than 20%
- The funds don’t have to be used but must be transferred to your bank account
- You still must provide a gift letter verifying the equity does not have to be repaid
Step #5: Apply for a mortgage
If you don’t have the cash to pay for a home, you’ll need to apply for a home loan. Make sure you let your lender know you’re buying a house from your parents, since it’s considered a “non-arm’s length” transaction. The concept of “arm’s length” is to ensure both parties in the deal are acting in their self-interest without pressure from the other party.
Even though you’re buying the home from a family member, lenders still have to verify you can repay the loan. You’ll usually need to provide:
- Your most current month’s worth of paystubs
- Your last two years’ worth of W-2s or tax returns
- Your most recent 60 days’ worth of bank statements
- Contact information for the homeowners insurance company you’ll use for your home
- Gift letters as detailed above (if you’re getting a gift of equity or cash gift for your down payment)
Step #6: Consider a seller carryback if you don’t qualify for a mortgage
If you’re denied a mortgage, your parents might be willing to consider something called a “seller carryback.” Instead of getting a home loan from your bank or a mortgage lender, your parents can act as the bank and you can make payments to them for a set time as you get your finances in order.
A note is usually recorded and a lien is placed on the home that must be paid off if you decide to sell the home.
Step #7: Close on the sale
To finalize the sale, you’ll need to schedule a closing. It can be at a bank or title company, or with an attorney. Be sure to look at the closing documents to make sure all the terms are correct, and that you’re each paying the closing costs and price you agreed to. If you’re taking out a mortgage, you’ll receive a closing disclosure three business days before the closing, and you can make any necessary corrections before signing the paperwork.
Pros and cons of buying a home from your parents
Before you decide to buy a home from a parent or family member, consider the pros and cons.
|You may not need any down payment||You could harm your relationship if the family member thinks they weren’t treated fairly|
|You won’t have to compete with other buyers for the home||Your parents could be taxed on gifted down payment funds|
|You may be able to ask your parents to be the lender if you can’t qualify for a mortgage||Your parents may have to gift a least 15% their home’s equity if you don’t meet special requirements|
Buying a distressed home from a family member
If you’re buying your parent’s home to help them avoid foreclosure and take out a mortgage to finance the purchase, additional conditions may apply. Lenders will be especially careful to document that you intend to live in the home if you are taking out a minimum down payment mortgage. Keep in mind: FHA loans are only for primary residence purchases, so you won’t be able to use an FHA loan unless you can prove you intend to live in the home for at least a year.
With conventional financing, the down payment minimum jumps to 20% for most lenders if the home is an “investment property,” and you won’t be able to get any gift funds for the down payment.