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An arms-length transaction in real estate is a purchase in which the home buyer and seller are unrelated in their business and personal lives, which ensures a fair market value for the home.
An arms-length transaction in real estate is when a home buyer and a seller agree on a deal and have neither a business nor a personal relationship.
Because the buyer and seller don’t know each other, it signals to the mortgage lender and other parties that the home’s sale price reflects current market conditions.
As an illustration, let’s consider two scenarios.
In the first scenario, a first-time home buyer purchases their childhood home from a parent at a reduced price as a favor. This purchase would fail the arm’s-length transaction test because the buyer’s and seller’s relationship likely influenced the property’s sale price.
In the second scenario, a first-time home buyer purchases a move-in ready home from a builder building homes in a desirable neighborhood. This purchase would be expected to pass the arm’s-length transaction test because the sale price is based on the home’s condition, location, and comparable home sale prices in the area.
Arm’s-length transactions are more likely to be mortgage-approved because non-arm’s-length transactions introduce lending risk. Lenders can’t know a property’s fair market value when a child buys a home from a parent or a cousin buys a home from a cousin.
Non-arm’s-length transactions are mortgage red flags. Only an arms-length sale gives lenders confidence that a fair market valuation supports their mortgaged amount.
Lenders care about arms-length transactions to ensure the property’s value is market-driven and unbiased. Personal ties can distort property values, increasing lending risks.
Transactions between family members are typically not considered arms-length because personal relationships can influence terms and pricing, leading to potential biases. An arms-length transaction requires both parties to have no personal ties, ensuring decisions are purely market-driven.
To prove an arms-length transaction, demonstrate no personal ties between buyer and seller, use a home appraisal and market analyses to validate terms and pricing, and negotiate via an impartial third-party, such as a REALTOR® or attorney.
Yes, mortgage lenders scrutinize non-arm’s-length transactions, which may affect loan terms, property valuation, and approval due to potential conflicts of interest.
A few non-obvious examples of non-arm’s length transactions in real estate include a property manager buying from a landlord they represent, a real estate developer buying a home from a contractor they frequently employ, a landlord selling to their tenant, a neighbor selling a home without an impartial intermediary, and a real estate agent buying from a client they’ve previously advised or represented.
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An arms-length transaction in real estate is a purchase in which the home buyer and seller are unrelated in their business and personal lives, which ensures a fair market value for the home. TABLE OF CONTENTS → A Longer Definition: Arms-Length Transaction → Questions Home Buyers Ask About About Arm’s-Length Transactions A Longer Definition: Arms-Length Transaction An […]
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