What Is An Arms-Length Transaction?

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Definition: Arms-Length Transaction

An arms-length transaction in the realm of real estate entails an agreement between a home buyer and seller who have no pre-existing business or personal relationship.

The absence of any prior connection between the buyer and seller serves as an indicator to the mortgage lender and other involved parties that the sale price of the property accurately reflects the current market conditions.

To illustrate this concept, consider two scenarios:

In the first scenario, a first-time home buyer acquires their childhood home from a parent at a discounted price as a gesture of goodwill. This particular transaction would not meet the criteria for an arms-length transaction since the existing relationship between the buyer and seller could have influenced the property's sale price.

In the second scenario, a first-time home buyer purchases a move-in ready home from a builder who constructs homes in a sought-after neighborhood. In this case, it is expected that the transaction would satisfy the arms-length criteria because the sale price is determined based on the property's condition, location, and comparable sale prices of similar homes in the area.

Arms-length transactions are generally more likely to receive mortgage approval, as non-arms-length transactions introduce a degree of lending risk. When a property is sold from a child to a parent or between relatives such as cousins, lenders are unable to ascertain the property's fair market value accurately.

Non-arms-length transactions serve as red flags for mortgage lenders. Lenders can only have confidence in the mortgaged amount when an arms-length sale takes place, as it is supported by a fair market valuation.

Questions Home Buyers Ask About About Arm’s-Length Transactions

Why do lenders place significance on whether my purchase constitutes an arms-length transaction?

Lenders prioritize arms-length transactions to ensure that the property's valuation remains impartial and market-driven. Personal relationships can introduce biases into property values, which in turn heightens lending risks.

Is any transaction involving family members classified as an arms-length transaction?

Transactions involving family members typically do not qualify as arms-length transactions since personal connections can influence terms and pricing, potentially leading to bias. An arms-length transaction necessitates that both parties have no personal ties, thereby guaranteeing that decisions are solely driven by market dynamics.

How can I substantiate that my home purchase transaction adheres to the arms-length criteria?

To establish an arms-length transaction, you can demonstrate the absence of personal connections between the buyer and seller, utilize appraisals and market analyses to validate terms and pricing, and engage in negotiations through an unbiased third party, such as a REALTOR® or attorney.

Could a non-arms-length transaction impact the approval of my mortgage?

Indeed, mortgage lenders subject non-arms-length transactions to rigorous scrutiny, potentially affecting loan terms, property valuation, and the approval process due to the potential for conflicts of interest.

What are some less obvious examples of relationships that do not meet the criteria for arms-length transactions?

A few less apparent instances of non-arms-length transactions in real estate encompass a property manager buying from a landlord they represent, a real estate developer purchasing a home from a contractor they frequently employ, a landlord selling to their tenant, a neighbor selling a home without the involvement of an impartial intermediary, and a real estate agent acquiring a property from a client they have previously advised or represented.

Additional Resources on Arm’s-Length Transaction

Related terms:

• Appraisal

• Fair Market Value

• Gift of Equity