If you're not up to speed with the term, you may be curious what an "arm's length" has to do with a home sale?
An Arm’s Length Transaction
In regards to buying and selling real estate, an arm's length transaction is one where the parties involved in the contract have no relationship to each other that would have an impact on their decisions during the purchase/sale of a property. A "relationship" can include: family members by blood or by marriage, business associates, beneficiaries, or even people that share a common business interest with each other.
In an arm's length transaction, all parties are deemed to have equal bargaining positions, unclouded judgment, and equal knowledge of the property being sold. Without a pre-existing relationship, it's confirmed that buyers and sellers will act in their best interest with no pressure.
When an arm's length transaction takes place, the sale typically reflects the home's proper market value. Since taxes and fees are based on a property's sale price, the government has a vested interest to ensure transactions are at arm's length.
Non-Arm's Length Transactions
When the sale of a home occurs and two or more parties have a pre-existing personal or business relationship that may be a conflict of interest, it is a non-arm's length transaction. This may also be called "identity of interest".
In a circumstance such as this, the property's sale price commonly varies from the present market value, and the loan may be regarded as high risk by the lender. Because of the increased likelihood of kickbacks, straw man buyers, inflated sale prices, fraud, and other adverse influences, lenders need to examine these loans more thoroughly.
Lender Restrictions & Requirements
When a borrower is searching for FHA financing in a non-arm's length transaction, a higher down payment is normally an underwriting condition. Rather than being approve to borrow as much as 96.5% of the home's value, a buyer may only be approved for up to 85% LTV (loan to value).
Sometime during the transaction, buyer(s) have to fill out an Identity of Interest Certification to reveal any relationships; so it's wise to take care of it upfront if there's an existing conflict of interest.
Do not forget with regards to short sales, FHA will not allow any relationships.
VA loans likewise has limitations on non-arm's length transactions, but only in certain situations. This can be found out by contacting a knowledgeable VA home loan lender.
As expected, Conventional financing will also have their restrictions on non-arm's length transactions, but it's not as firm as an FHA or VA loan. When it comes to a short sale transaction, guidelines call for an arm's length transaction affidavit to confirm there is not any relationship between the buyer and seller.
The affidavit states that there are no hidden/implied terms or special understandings between the parties that have not been included in the contract or otherwise disclosed. Disclosing false information on this form could make you liable for mortgage fraud.
The affidavit also has conditions that prevent any proceeds from the sale to be given to the buyer or seller directly or indirectly. The same language applies to the seller's agent. In a short sale, the seller is basically walking away from the property with nothing. Furthermore, the seller is not permitted to rent or live in the property post-closing.
