How FHA identity of interest can affect your down payment

If someone you know, like a family member or your landlord, is selling a property you’re interested in, you may think you struck gold – especially with the current housing market conditions.

But hold on just a second. Because if you’re planning on applying for a Federal Housing Administration (FHA) loan, this relationship is known as an FHA identity of interest, which could harm your chances of mortgage approval.

A home transaction between a buyer and seller who know each other before the sale of a property may be viewed as a red flag by the FHA loan office in certain situations. So, before you move forward with the transaction, you’ll want to know how an FHA identity of interest can impact your home purchase and what you can do about it.

What is identity of interest in terms of an FHA loan?

When applying for an FHA loan, the identity of interest means there’s a preexisting connection between the property’s buyer and seller(s), such as a family or a business relationship. This can refer to a transaction between a parent and child or a corporation and employee, along with other combinations of people related through other affiliations.

For example, let’s say you want to buy your childhood home from your parents, or you’re interested in purchasing your condo from your landlord. Both buyers in these examples have a relationship with the seller.

In this type of transaction, it’s assumed that the buyer isn’t paying fair market value for the property. In other words, it looks like you’re getting a great deal on the property since it won’t likely hit the open market. Because of this, other potential buyers won’t have the opportunity to compete for it. While this might be favorable to you, the U.S. government begs to differ. 

FHA non-arm’s length transaction

It’s important to point out that an FHA identity of interest is also known as an FHA non-arm’s length transaction. Regarding FHA loan terminology, you’ll hear this transaction referred to as identity of interest.

How can FHA identity of interest affect borrowers?

So, how does an FHA identity of interest apply to you as a borrower? Well, the identity of interest can affect FHA lender down payment requirements.

FHA lenders usually require a minimum down payment of 3.5% of the home's purchase price. However, with identity of interest transactions, you can expect the requirement to increase to 15% of the purchase price. As the home buyer, you must come up with a bigger chunk of change to receive an FHA loan approval.

Usually, government loans like FHA loans offer lower down payment requirements. This is because government loans are guaranteed by the federal government, which reduces the lender’s default risk.

Government loans are usually appealing to households that have low-to-moderate income levels and haven’t set aside a significant amount of money for a down payment. So if you’re planning to purchase a property from someone you know, selecting an FHA loan may no longer be the most appealing option.

FHA identity of interest exceptions

Fortunately, there are a few exceptions to the identity of interest down payment rules. To keep the down payment at 3.5%, a borrower must meet one of the following FHA identity of interest requirements:

• You’re buying the primary residence of a family member, domestic partner or fiance.
• You’re buying a property from a landlord or family member you’ve lived in for at least 6 months before purchasing it.
• You’re buying a home your employer owns as part of a job relocation agreement.

The bottom line

FHA loans have low down payment requirements, making them appealing if you haven’t saved enough. But, if you’re buying a property from someone you know, the transaction is now an identity of interest, which can increase the FHA loan down payment requirement to 15%. Therefore, exploring other financing options such as a conventional loan may be more suitable for your situation.

Get started with Rocket Mortgage^® and see if you qualify for a government home loan today!