You've agreed to buy a home from a family member, your landlord, or a business associate — and you're planning to use an FHA loan to finance it. Then your lender mentions something called FHA identity of interest, and suddenly your expected 3.5% down payment may have jumped to 15%. That's a real number on a real purchase. On a $350,000 home, you're looking at $52,500 instead of $12,250.

This catches borrowers off guard constantly. In our experience, most people buying from someone they know — a parent, a landlord, a former employer — don't find out about the identity of interest rule until they're already deep into the loan process. The good news: the transaction isn't prohibited. FHA allows these sales. But the rules are different, and there are specific exceptions that can bring the down payment back to 3.5% if you know about them early enough to prepare.

What Is FHA Identity of Interest?

An FHA identity of interest (IOI) is any pre-existing relationship between the buyer and seller in a home purchase that could influence the terms of the transaction. FHA classifies these as non-arm's length transactions — meaning the deal isn't happening between two unrelated strangers negotiating at fair market conditions.

Per HUD Handbook 4000.1 (Section II.A.1.b.ii), an identity of interest transaction is defined as a sale between parties with an existing relationship, including family members, business partners, or other affiliations. The relationships that trigger the rule include:

• Family members (parent and child, siblings, spouses, in-laws)
• Employer and employee
• Landlord and tenant
• Business partners or co-owners
• Any parties with a financial interest in the transaction beyond the sale itself

FHA's concern is straightforward: when the buyer and seller know each other, there's a higher risk the sale price could be inflated above market value to pull more cash out through financing. The identity of interest rule is a safeguard against that. It's not a penalty — it's a risk adjustment. According to HUD's 2023 Annual Report to Congress, the FHA Mutual Mortgage Insurance Fund insures over $1.3 trillion in single-family mortgages, and protecting that fund from artificially inflated transactions is part of why these guardrails exist.

How the FHA Identity of Interest Rule Changes Your Down Payment

Under standard FHA loan programs, borrowers with a credit score of 580 or higher can finance up to 96.5% of the home's value — putting just 3.5% down. When the identity of interest rule applies and no exception is met, the maximum loan-to-value (LTV) drops to 85%. That means a 15% down payment.

According to HUD's FHA Single Family Housing Policy Handbook (4000.1), the maximum LTV for a non-exempt identity of interest transaction is 85% of the lesser of the appraised value or sales price. That "lesser of" detail matters. If a parent sells their home to a child for $300,000 but the appraisal comes in at $280,000, the 85% LTV is based on $280,000 — not the $300,000 sale price.

Here's what that difference looks like in real dollars across different price points:

The additional cash burden is significant. A borrower who budgeted $12,250 for a down payment on a $350,000 home now needs to come up with $52,500 — that's more than four times what they expected. This is why understanding the identity of interest rule before you sign a purchase contract matters so much.

Exceptions That Restore the 3.5% Down Payment

The 15% down payment requirement isn't absolute. HUD has defined three specific exceptions where identity of interest transactions can still qualify for the standard 96.5% LTV. Each has its own conditions, and meeting them requires documentation — not just a verbal claim.

Per HUD Handbook 4000.1, the following exceptions allow the borrower to retain the maximum 96.5% financing despite the identity of interest relationship:

The Tenant-to-Owner Exception

This is the exception we see used most often in practice. If you've been renting a home and your landlord offers to sell it to you, FHA recognizes that you already live there and have an established payment history on the property. The requirement is clear: at least six months of documented tenancy before the date of the purchase contract.

The key word is "documented." A handshake agreement where you've been paying rent in cash won't cut it. You'll need a signed lease and proof of payment — bank statements showing regular rent transfers, canceled checks, or similar records. According to the CFPB's guidance on buying a home, lenders are required to verify the information borrowers provide, and identity of interest documentation receives extra scrutiny during underwriting.

The Corporate Relocation Exception

This exception is narrower than most people realize. It doesn't apply to any employer-employee home sale. It specifically covers situations where a corporation buys an employee's home as part of a relocation package and then sells that property to another employee of the same company. The company acts as an intermediary. Direct sales between an employer and employee outside of a formal relocation program don't qualify for this exception.

The Family Gift of Equity Exception

This is the exception that generates the most questions. When a family member sells a home to another family member below market value, the difference between the sale price and the appraised value can be treated as a gift of equity — functioning like the buyer's down payment.

The catch: either the seller or the buyer must have lived in the property as their primary residence for at least six months before the sale. If a parent owns a rental property and wants to sell it to their adult child at a discount, this exception wouldn't apply unless one of them has actually been living there for half a year.

What Lenders Need to See in an FHA Identity of Interest Transaction

Lenders don't have a choice about investigating identity of interest — it's a requirement of FHA underwriting. According to HUD Handbook 4000.1, the lender must determine whether there is an identity of interest between the buyer and seller and document the nature of that relationship in the loan file.

The specific documentation depends on the relationship type:

• Family members: Birth certificates, marriage certificates, or other records establishing the relationship
• Landlord and tenant: Current lease agreement, rent payment history for the preceding six months
• Employer and employee: Employment verification, relocation agreements
• Business partners: Business registration documents, partnership agreements

If you're claiming an exception to the 15% down payment requirement, you'll need documentation proving you meet the exception conditions on top of the standard relationship verification.

What Happens If You Don't Disclose the Relationship

We bring this up because borrowers occasionally ask whether they can simply not mention that the seller is a relative or former landlord. The answer is clear: don't do this. According to federal law (18 U.S.C. § 1014), making false statements on a mortgage application — including omitting a known relationship between parties — is a federal offense carrying potential fines and imprisonment. Beyond legal risk, FHA's underwriting process is designed to catch these relationships. Title searches, address histories, tax records, and other verification steps often reveal connections that borrowers assumed were private.

If an undisclosed identity of interest is discovered during underwriting, the loan will likely be denied or significantly delayed. If it's discovered after closing, the FHA insurance on the loan could be rescinded, which creates problems for both the lender and the borrower. Full disclosure up front — paired with proper documentation — is always the right approach.

How to Prepare If You're Buying from Someone You Know

If you're considering a purchase from a family member, landlord, or business associate using FHA financing, the single most valuable thing you can do is talk to your lender before you sign any purchase agreement. We work with borrowers in Colorado and Florida on these transactions regularly, and the ones that go smoothly are the ones where the identity of interest question comes up early — not after a contract is already in place.

Here's what that preparation looks like in practice:

• Identify your relationship type early. Be upfront with your lender about who the seller is and how you're connected. This determines whether the 85% LTV cap applies and which exception, if any, might be available.
• Gather documentation before applying. If you're a tenant buying from your landlord, make sure your lease is signed (not informal) and that you have six months of verifiable rent payments. If it's a family sale, confirm who has lived in the property and for how long.
• Get the appraisal expectations right. In family transactions, the sale price is often below market value. That's fine, but remember that LTV is based on the lesser of the appraised value or sale price. An appraisal that comes in lower than expected can affect your financing even if you've negotiated a favorable price.
• Plan for the 15% scenario. Even if you believe you qualify for an exception, have a backup plan in case the documentation doesn't satisfy underwriting requirements. If 15% down isn't feasible, a conventional loan may have different rules for non-arm's length transactions worth exploring.
• Work with a lender experienced in these transactions. Not every loan officer handles identity of interest deals regularly. Working with someone who understands the FHA guidelines and has processed these transactions before can save you weeks of delays and prevent surprises at the underwriting stage.

According to a CFPB report on mortgage shopping behavior, more than 75% of borrowers applied with only one lender, meaning most didn't compare how different lenders handle complex situations like identity of interest transactions. In a transaction where the down payment requirement can swing by tens of thousands of dollars depending on documentation, getting experienced guidance from the start makes a measurable difference.

Frequently Asked Questions