Defining Arm's Length

• An arm's length transaction, according to the Greater Chicago Housing and Community Development Department, is one in which the involved parties do not have a conflict of interest or reason for collusion: "The parties are strangers to each other." Other definitions of the same term stress the absence of a conflict of interest and are less specific when it comes to any prior relationship between buyers and sellers. The point of an arm's length transaction is that it produces a market-rate sale -- a sale based on nothing but normal market forces and results in the highest price the buyer can get.
  
  

Arm's Length Implementation

• Each lender has its own rules when it comes to arms-length transactions. Some will prohibit a sale to anyone who is related to the buyer. Others may prohibit any sale to a buyer the seller has met beforehand. The bank may require both buyer and seller to sign an affidavit before closing indicating they do not know each other. Signing a statement like that when it is false could constitute fraud, whether there was any sort of collusion on the price or not.
  
  

Talk, Don't Guess

• When you are considering a short sale, contact the lender and ask what its arms-length transactions rules are and ask for a copy of the affidavit it will ask you to sign. If you want to sell to a relative, take the time to prove the sales price is market rate. Tell your lender you will pay for an appraisal if it hasn't already performed one. Consider asking the buyers to increase the price -- offering a bit over market-rate to prove to the lender this is no scam. Remember, the lender's ultimate concern is not the identity of the buyers but that the buyers pay a price that is fair.
  
  

Other Ideas

• If the lender does not approve your short sale, resign yourself to selling to someone you don't know. However, you may talk to your relatives about buying another property -- a short sale by another seller or a foreclosure being sold by a lender in the same neighborhood, for the same price. There are no arm's-length transaction rules that apply to a sale between your relatives and another seller. You could pre-arrange a lease/option so you could buy the house back from your relatives once you re-establish your credit. In the meantime, they could be profiting with a market-rate rent to cover their mortgage.