When purchasing your first home, a substantial down payment could put you on track to a great mortgage program, give you more equity in your home, and ultimately result in lower monthly payments.
Saving up this much money isn’t always possible, however. That is why over a quarter of first time buyers rely on gift funds from a relative to use toward their down payment, according to research by the National Association of Realtors (NAR).
If you’re fortunate enough to have generous parents or a rich uncle who is willing to help you out, just know that it’s not as simple as them handing you a check.
Here’s what you need to know about financial gifts and the mortgage application process:
1. Gather the Required Paperwork
Banks and mortgage companies will question the fact that thousands of dollars suddenly appeared in your savings account.
They need to make sure that the funds were obtained legally, and that they are in fact a gift, and not a loan. A loan comes with payments which jeopardize your ability to pay back the mortgage.
To confirm a no-strings-attached gift, you and your benefactor need to create and sign a gift letter. You can download a gift letter template here.
There may also be another step in which your donor has to prove that they have the means to offer the gift. Usually, that just involves them having to supply a current bank statement.
Naturally, the more money involved, the more questions your lender could have. Once you’re ready to accept the gift, be sure that you create a gift paper trail by keeping the deposit slip that shows the transaction, and make a copy of the check before you deposit it.
2.IRS Gift Rules about Down Payment Gifts
Before your parents or close relatives try to help you out, do them a favor and make sure they are aware of the IRS annual gift tax exclusion rules. It basically states that one person can give up to $14,000 (during the 2014 and 2015 tax years) to another individual without having to pay a gift tax.
However, if both your parents are contributing, each person could give a gift, bringing the total to $28,000. And, if they each want to give to you and your partner/spouse if you’re buying the home together, those separate gifts can take the amount up to $56,000. As with all tax-related advice, speak to a tax professional to help guide you.
3. You May Need Additional Funds Beyond the Gift
Depending on the loan program you’re aiming for, how much money you put down from your own funds versus your gift donor’s money could be a factor. In other words, just because your relative is giving you a large sum of money, if you have nothing to contribute of your own, you might not qualify for certain loan programs.
For example, with a conventional loan on a duplex, triplex, or four-plex, you have to have at least 5% of your own funds. The same is true if the loan amount is over $417,000.
Other conventional loans, and FHA and VA loans allow the entire down payment to come from a gift source.
But remember, mortgages require closing costs. For instance, if your loan requires a $20,000 down payment for which you receive a gift, you still have to have enough to cover closing costs. These fees, like mortgage broker charges, title, escrow, and appraisal fees typically range from $3,000 to $5,000.
The good news is that most loan programs allow you to receive gift funds to cover closing costs as well.
4. What Is the Donor’s Relationship to You?
If the person giving you money is not an immediate relative like a parent, sibling, grandparent, aunt or uncle, you may have to verify your relationship to the person.
According to the HUD Handbook (which sets rules for FHA loans) the giftor may be a(n)
- Charitable organization
- Government or public agency
- Close friend with a documented long-term relationship
On the flip side, a donor may not be
- A seller
- A real estate agent or mortgage lender
- A builder
- Any entity with a benefit in the purchase or sale of the home.
Have a Down Payment Gift? Get Started on the Home Buying Process.
Having a cash down payment gift is a wonderful thing, and is often what allows first time buyers to become homeowners. By accepting your gift by the book will ensure a smooth application process.