Because the lender is agreeing to lose money in this type of transaction, they will only do so if they can confirm that the transaction is a normal, arm’s length sale. In a short sale, the property owner gets their lender’s approval to sell their property for less than the amount owed on their mortgage, which has a negative financial impact on the lender. Here are some common situations where non-arm’s length transactions can be found: While non-arm’s length transactions are often associated with property sales within the family, this category extends to any form of a close relationship-from friends to landlords, co-workers, and more. Most non-arm’s length transactions do not qualify for a conventional mortgage, so the buyer must comply with FHA loans under specific conditions.īy contrast, it is much easier to obtain a mortgage if the transaction is arm’s length, as the lower-risk circumstances would be treated with much less scrutiny from financial authorities. If a particular exchange falls under their radar, usually through an unusual-looking sale price, they may conduct an investigation or request documentation to prove otherwise. In this case, the lender would have taken a loss, while the homeowner would have been able to keep the property at a smaller mortgage with a family member’s insider help.Īs a result, lenders are wary about sales that could result from a non-arm’s length transaction. However, the homeowner may coerce a family member to purchase the home for a significantly marked-down price and transfer ownership back later. For instance, a homeowner who is financially struggling may get a lender’s approval to short-sell their property, which means they can sell the home for a smaller value than their mortgage. Lenders favor arm’s length transactions because there is less risk of mortgage fraud and similar forms of cheating. Why Do Lenders Favor Arm’s Length Transactions? However, they may face taxation difficulties, as property taxes are based on property’s assessed value, which, in turn, is based on its fair market value. For example, a seller sells a house to their friend for less than what it is worth but with no intention to commit fraud. Apart from taking advantage of their child, the parent has committed mortgage fraud, which comes with stiff penalties, even imprisonment.Ī non-arm’s length transaction may also involve underpaying for a property’s assessed value. The child may trust their parent’s recommendation and thus overpay. A non-arm’s length transaction opens either party and the lender to risk, as the terms and price of the transaction may be tilted in favor of one party or the other, rather than an objective sale between both parties.įor instance, a parent may ask their child to purchase their $500,000 home for $800,000. The nature of this type of transaction can result in issues, including the manipulation of a property’s true value. On the other hand, a non-arm’s length transaction is one where there is an existing relationship between the buyer and seller. These transactions are more likely to result in a sale that is in alignment with the property’s fair market value. In other words, an arm’s length transaction is a normal real estate transaction.Īrm’s length transactions are usually objective: the buyer would push for a lower price while the seller would insist on the highest selling price possible. As a result, they would objectively act in their own self-interests, reducing the chances of manipulation due to either trust or compulsion. The distinction is important to prevent manipulation from either party and ensure a fair sale.Īn arm’s length transaction is one where the buyer and the seller are independent i.e., they have no relationship or connection with each other. The relationship between the buyer and seller in property-related transactions can be classified into two categories: arm’s length and non-arm’s length.
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