In a non-arm's length transaction, the seller and buyer have a connection by marriage, family or other dealings, while the parties in an arm's length transaction have no connection. As a result, lenders often view the former type of transaction as a risk because the final price may not reflect the actual value of the property.
Borrowing money from the FHA for a mortgage usually requires a loan-to-value amount of 85 percent in a non-arm's length transaction, although this can be waived if the buyer has already been a tenant on site for a minimum of six months before the sales contract. Other exceptions include an employee of a home builder buying a house or relocation companies purchasing a home and then selling it to another employee moving into town.
Short sales are also an area of contention with non-arm's length transactions, as many lenders require an affidavit that the transaction is at arm's length. The nature of these transactions already raises red flags with lenders, because they are accepting a sale for less than the value of the home. Also, some non-arm's length transactions come with tax implications when a sale happens for a lower amount than the fair market value.