We aimed to investigate to which degree the home environment and/or primary caregivers' level of functioning mediate the association between parental mental illness (eg, schizophrenia) and child psychopathology. We used data from the nationwide Danish High Risk and Resilience Study-VIA7. The study sample comprised 522 seven-year-old children. The main outcome was the child psychopathology, assessed with the Child Behavior Checklist (CBCL). The exposure variable had 3 categories: children at familial high risk of schizophrenia spectrum psychosis (FHR-SZ), bipolar disorder (FHR-BP), and population-based controls. Mediators were quality of the Home Observation for Measurement of the Environment (HOME) and primary caregiver's Personal and Social Performance Scale (primary caregiver functioning). Primary caregiver's IQ and polygenic risk scores (PRS) for the educational attainment of the children were considered as covariates. We found a significant indirect adjusted effect of FHR status vs controls on CBCL total scores (FHR-SZ = 5.34, 95% confidence interval [CI]: 3.50-7.47 and FHR-BP = 4.54, 95% CI: 2.65-6.68), through primary caregiver functioning and HOME. Both mediators combined explained 53% and 64% variation of the total effects of FHR-SZ and FHR-BP, respectively. Adjusting for the PRS in the mediation models only resulted in minor changes in the FHR effects on the CBCL. We conclude that the HOME and the primary caregiver functioning are important mediating factors for child psychopathology, especially in children born with familial risk for severe mental illness. This knowledge may represent a window of opportunity for the development of preventive strategies (eg, intervention to improve primary caregiver functioning and home environment).