My opinion on this: neither house is suitable and I wouldn't buy either.

Buying a house is a huge expense and often locks you in to a specific house or area for a long period of time. It is somewhat like marriage: be fussy, have some standards, choose wisely: then enjoy or repent at leisure... I dont see the point of "settling" when you have a greater choice; and it is costly to get out of a mistake, Both of these statements apply to houses and marriages.

You need to make a list of the non-negotiables you want in a house with your DH. Carefully select what goes on that list because it would be NON-negotiable. Find a house that matches these closer to where one (or both) of you work, because an hour long commute makes a difference in terms of getting up early, traveling with or against the traffic, fuel costs, wear and tear on the car and overall daily stress. Been there done that: not worth it.
A shorter commute is always better even if you pay more for your house because whereas your car is a total liability, you are working to convert the house into an asset.

I would look for a house that meets my non-negotiables in an area closer to where I work. My commute is 10 minutes and it is very convenient.

Settling for a house is going to leave you with disappointment at best and resentment at worst. Although it will be nice to buy FIL's house it comes with baggage and quite a few deficiencies already. Unless you are a DIY fixer upper type person, buy the house that needs the fewest changes. It is not your job to build your future on FIL's past. The house suited him and his family. It doesn't suit yours. Take sentimentality out of financial decisions.

Neither of these houses sound ideal. Apologies, I doubt that is what you wanted to read.

DO not buy a house because you saved up money to do so and wants to spend it now... it's much much more then that..

and I would buy a house as per list.

Commute to work, school, family....... needs to be close by
Location
size of the house, at least 3 bedrooms....... 2 bathrooms, nothing smaller
affordability
safety

see a whole list of things, and then you decide and you give a flying duck if it's close to BM or FIL or if it's FIL's house or not...
buying a house is serious business and if you can't find the right one now, save more and wait...

I wouldn't buy either. I wouldn't pay full market value on a home that needs repair, is tiny, not suitable for your family, will come with an extra family member to look after and family drama. Seriously, if it were a stranger would you pay full market value on a home that you have to also fix up to allow the seller to live in? That is stupid....then add the family drama and the idea is even more dumb. If you did go that route, I would expect a steep discount. No one is going to pay top price for a home that needs a ton of work....don't be stupid with your money just because it is a family member. And renovation is always more expensive than you think.
An hour commute one way is not realistic. That is a pain in the butt to drive and you need to take that home off your list. Just because you have the downpayment saved doesn't mean you need to buy the first thing you see. Right now the market is slow because of the holidays. More people will put homes up for sale in a few months, hoping to move during summertime. Neither of these houses will suit your family, don't settle just because you think that is all that is available.

Last summer we renovated my uncle's old house. My SO works in the trades and can do just about anything 10k later we have a beautiful home but with two full time jobs and 3 kids (2 of which live with us full time) I would feel very confident in saying April-November 2016 was hell on earth. I will NEVER do it again.

On top of that most of my work is 1 hour or so away (I work from home but have field work). Most of SO's jobs are that far away too. My BD is in daycare around the corner from my house and SS's school is 15 minutes away. If I'm out in the feild and one of them need me it's an ordeal. Or if I get stuck at work late or hit traffic. Everything has to be carefully coordinated and sometimes have to rely on friends/family for pick ups.

My SO and I just bought a house this year back in March. We had some options.

1. Buy his parents house because they wanted to move to FL.....I said no due to an hour commute to work and it was a pretty big house and too much for us who both work and are always running around. I did not like the drive way or where it was located up on a big hill with a windy drive up to it. I live in the north no thank you. You literally need a plow to get out in the snow.

2. Was to look for a place in between both our jobs a the time. We chose this option.

Things we looked for when looking. He wanted a large big yard, wanted to be kind of secluded and more out in the country. I wanted in town more and not be so far away from everything. He got his wish as we found a place that was affordable. I wanted a house that needed work and could fix up so we tried to keep the price tag low. I wanted hard wood floors because I hate carpet. Also wanted a house with three bedrooms and two bathrooms because I did not want to share a bathroom with a grown man and a boy forever. I did not want a big house and when we started looking I fell in love with the idea of a ranch home.

Eventually we found a house built in 88. A brick (bonus because brick is a great) ranch, that was two bedrooms and one bathroom. The bathroom was huge and the one bedroom was really large. With help from his dad we converted the house into three bedrooms and two full bathrooms. We have a masterbath. Nothing fancy stand up shower but it is really nice. It was all carpet so we installed hardwood throughout the whole house. Some stuff did have to wait. We both really want central heating/cooling. That has to happen later as we do not have the money, the kitchen is really outdated and not functional so that has to wait too.

This is long but buying a home that needs work takes time and patience. Sometimes it is worth it but it is work and plenty of it. I would not want to do an hour commute I commute about 35 minutes each was everyday to work and you loose a lot of time. Hour each way is two hours lost spending with family and doing things around the house.

If you do not like FIL's do not buy it. Start hunting more and really look at what you want in a home. Also keep in mind if you want this to be a home you grow old in. Too big of a house you will end up downsizing after all the kids are older and out. One thing I love about the house SO and I got. It is small 1400 sf feet. I do not mind because I like that we all are forced to hang out and that as we get older we will still be able to manage and take care of everything.

Buy a new house.

A house with personal history ties to one of you brings back memories.
It will put you at a disadvantage.

Even if the Dad sells it to you, as long as he is alive it will never truly be your house because of the father.

You will live with the ghosts and shadows of other people. Buy a different house no one has ties to.

How long are your current commutes to work? To FIL’s house? To BM’s?

I agree with all the other people who say that neither house is a good option.

A house is a big investment and it is a big financial risk to tie up your assets and obligate yourself to buying something that expensive that you will be paying for over a long period of time.

I say expand your search. Explore areas that are going to be convenient to your jobs. (assuming work is stable and expected to stay that way). Look for houses that have key characteristics. Even expand your price point to see if it will be worth putting the purchase off a little longer to save more money. If all you can afford is 125K now and you see perfect homes for 175... get to saving and wait for a time when you can afford a bit more... instead of settling.

As far as your relative, perhaps you could think of looking for a place already set up with a MIL suite? Maybe he would be open to selling HIS home and perhaps paying you rent (which would offset your mortgage). Since he isn't working.. location would not be as important right?

I would vote against commutes over an hour.. there is so much extra time wasted in your life.. money for gas.. wear and tear on YOU and your vehicles... just not a great option. coming from someone who has commuted a 2hr each way and 1hr each way for several years.. it is expensive and stressful. You are better off spending more for a home closer!

I would keep looking. The right house or at least the almost right house is out there somewhere.

That commute is too long if you have kids. You will be exhausted. Also imagine trying to get to school and back to work in the middle of the day if the kid needs to see a doctor (this is a big deal for us as Dd developed a health problem. It just isn’t possible to limit appointments to times when she isn’t in school)

The too small house that strains your finances and comes with family drama is a bad idea.

You have to figure the real expense of driving an hour each way.
1, weather. Snow could turn it into a four hour trip. Not to mention. Putting your life in danger for 5 hours

2. An Hour one way that 60 miles, 120 a day, 600 a week, 50 weeks 35,000 miles with out doing anything else with the car.
40,000 a year 80,000 in two years. You need a car every three or 4 years. So add monthly car payment you will always have one. Can’t buy a clunker. Exter car repairs. Like 12 oil changes. Break job ever year. Ect. Not worth it

I'm in the "neither" camp as well.

I bought an old house that needed renovations because of family pressure and a family member was supposed to move into the basement apartment when she retired. She bailed on me. I was stuck with a dump that cost me tons of money and no rental income. To say that I was disappointed and frustrated throughout my years in that house would be an understatement. I always regretted buying that house over another one I had my eye on that didn't need any work.

Keep looking.

Keep looking.

Buying a house is too big of an investment (in more ways than one) to settle for something just because you think you can live with the cons.

I got very depressed when house hunting for my first home. Searching for what I wanted, within my budget, and in the area that I wanted, was exhausting. But, I knew that I didn't want to do it again five years later, so we looked and looked and kept on looking until we found what we wanted, where we wanted. Sixteen years later, I am in the same house and am still happy with it.

And, the extra time that it took to find, allowed me to save extra money for an even bigger down payment, which really helped.

Actually, we found this house pretty early on but there was already a contract on it and... it's a long story, but patience was key. It was NOT a fun process but it was worth it.

I'm also in the neither camp, but the commuting house would be the better of the two in my opinion. Both from the experience of commuting an hour to work every day and from the experience of living in a house that's too small for us.

Commuting House: If you go this route, be prepared to spend a lot more than you anticipated on gas/oil changes/maintenance. It wears on the vehicles much faster than you think it will, and you need to be prepared with that in your budget. You also have to make sure you are taking into account the additional time away from the family and traffic problems. When you travel for an hour there are multiple points where 'rush hour' traffic can affect you. That all being said, it's doable. And your commute time can become your own kind of zen/me time as well. I wound up enjoying the drive.

Grandpa's house: If you go this route, please google information on 'big family, small space'. It can be done but it takes dedicated effort. There will be resentment from SIL, even if you choose to ignore it. Once FIL passes, SIL may even cause you legal problems. It won't get her anywhere if you have the deed/bill of sale, but it might still be a pain in the ass that you shouldn't have to deal with. Even if you buy it from FIL, chances are he won't be 100% on board with too many changes. (Unless he's a keep-moving-forward type, )

My suggestion would be to wait and find the right house, with an in-law suite or space for an in-law suite. Then FIL can sell his home and move in with you and you still have the benefit of seeing him without the problems of a house that doesn't work for you.

Keep looking. There has got to be more houses out there then these 2.

I am in the keep looking camp as well.