Buying a home has become increasingly challenging, with mortgage rates (1) and home prices (2) both soaring in recent years. So it’s no surprise that around 25% of young people (3) who actually managed to buy a home had help from their family with a down payment.
But what if your family doesn’t just give you a down payment, but instead they sell you an entire home at a substantial discount?
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Let’s pretend, for example, that Chris and Megan, who are in their 30s, have been married for a few years, and Megan’s parents want to sell the couple their $800,000 home for $400,000.
Chris and Megan want to figure out the best way to structure the deal so it works out for everyone involved. What should the couple do, and is this a good option for them to get a property of their own?
Structure the deal in the right way
While it may seem like a smart approach for Megan’s parents to just sell them the house for half off, that’s not actually the best method, according to mortgage experts.
“I would not recommend simply lowering the purchase price,” Byron Davis (4), founder of ShopDPA and a mortgage loan originator with Primary Residential Mortgage, Inc., told Moneywise. “Instead, I would recommend structuring the transaction at the property’s full market value using a gift of equity and seller concessions to cover the buyer’s down payment and closing costs.”
Davis told MoneyWise that this approach would be the best option because it would provide the couple with a better loan-to-value ratio, help them qualify for a better mortgage loan and avoid having to pay closing costs out of pocket.
He laid out the situation the couple in our example is facing and explained that, if a borrower has a $400,000 first mortgage on an $800,000 property, this results in a 50% loan-to-value ratio: “Financing only 50% of a property’s value represents significantly less risk than financing 80%, 90% or 95%. That lower risk can translate into more favorable mortgage pricing.”
Sarah DeFlorio, vice president of mortgage banking at William Raveis Mortgage, agreed that the difference between the appraised market value and purchase price should be considered a gift of equity, and said that most mortgage lenders should be fine with doing the deal this way.
“This should not have an impact if it is structured correctly, meaning that the difference between the appraised market value and the purchase price is considered a gift of equity from the family member,” DeFlorio told MoneyWise. “You do need to disclose the relationship to the lender upfront, and the donor will be required to sign a gift letter.”
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Ensure the home is affordable in the long run
While the couple is getting a deal, it’s also worth noting that an $800,000 house could have high property taxes, HOA fees, insurance costs and utilities. Megan and Chris must be sure they can afford those expenses.
Ideally, the total costs of their housing will be no more than 30% of their income (5). If the couple needs a $400,000 mortgage and the mortgage, taxes and insurance payments put them above this, they may end up facing financial problems, even with the discounted sale price.
Finally, the couple must consider the implications of accepting a gift like this.
“A discounted home purchase between family members is never just a real estate transaction. It’s a major shift in the family system, which could impact power and agency for those involved,” Matthew Willner, a psychotherapist licensed in New York, New Jersey and Colorado, told MoneyWise. “The discount doesn’t disappear upon closing. It remains an emotional debt, and nobody agrees on the repayment terms.”
An ’emotional contract’
Willner advised naming the “emotional contract,” not just the financial one, which means discussing both their motivations and potential concerns in detail before moving forward.
Dr. Larry Schooler, an assistant professor of practice at the University of Texas at Austin, also warned of other potential pitfalls. “The risks associated with the discounted home purchase include unmet expectations from the seller that they will be entitled to future concessions, discounts or considerations,” he told MoneyWise.
Schooler explained that the parents may think they’ll retain access to the house or could have remorse later, or that Chris and Megan could be left with regrets if it turns out the property has unexpected issues that require a big investment.
He recommended discussing why the discount makes sense, what the buyer is committing to doing with the property and whether any conditions could cause the seller to reacquire it. He also suggested that they “clarify that this transaction should not obligate either party to do anything else on other matters going forward, that those would be separately negotiated.”
If the couple decides to go ahead with the purchase, taking these steps, as well as working with a mortgage lender to structure the deal with a gift of equity, is the way to go.
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Freddie Mac (1); Federal Reserve Bank of St. Louis (2); Redfin (3); Shop DPA (4); Town of Westborough (5)
This article originally appeared on Moneywise.com under the title: My in-laws want to sell us their $800,000 home for 50% off — what’s the best way to make this family deal work?
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
