One thing you should know as a first time or repeat home buyer is that mortgage lenders allow financial gifts to be used toward the down payment on a house. Gift funds are a valuable tool for first time home buyers and repeat buyers alike. Yet, first-timers are usually the ones who benefit the most from this lending guideline.
If you are looking for a first time home buyer program, explore the possibility of receiving a downpayment gift. Buyers can use a gift for conventional loans, as well as FHA, USDA and VA. In fact, FHA gift funds can reduce the buyer’s required cash to zero.
No matter what type of loan you will apply for, a gift from an eligible source can give you a leg up when qualifying for your first home mortgage.
In this article:
- Using gifts with conventional financing
- FHA gift funds
- Down payment gifts for USDA and VA loans
- Who can give gifts?
- What gifts are unacceptable?
- Sample mortgage gift letter (pdf)
- Gift money documentation
- What is a gift of equity?
- Our recommended lenders for home loans
Conventional loans backed by Fannie Mae and Freddie Mac allow the borrower to apply financial gifts to the down payment, fees, and closing costs.
The borrower usually does not need their own funds when receiving a gift if the gift covers the entire down payment and other loan costs. (In the past, the borrower needed 5% of his or her own funds.)
According to Fannie Mae, the minimum 5% borrower contribution is only needed when:
- The gift amount is less than 20% of the purchase price, and the property is 2-4 unit or a second home
- If the loan amount is over $484,350
To clarify, the borrower does not need any of his or her own funds when receiving a gift that covers the entire down payment and closing costs, unless the final loan amount is over $484,350. If the gift amount does not cover all upfront costs, the borrower needs to prove they have the money to cover them, or receive a higher gift amount.
You may be thinking that it’s pretty rare for someone to give away enough money to cover the entire down payment and closing costs. But, it happens a lot more than you might think, and has allowed many homebuyers to achieve homeownership much earlier than they would have on their own.
The typical FHA consumer makes a 3.5% down payment on a home. This means that if the purchase price is $100,000, the borrower needs to come up with $3,500. For an FHA loan, this 3.5% is called the required “minimum investment.”
The minimum investment is the FHA’s way of making sure the homebuyer has “skin in the game” which lowers risk of foreclosure.
But there’s one exception to the minimum investment rule. It can be a financial gift. That’s the difference between FHA and conventional. FHA allows any or all of the 3.5% minimum investment to be a gift. Borrowers do not need to contribute their own funds if receiving a gift for the full 3.5% down payment.
Using gifts on USDA and VA loans is not as common, because these are both zero down programs. However, borrowers may find themselves in a situation where they need to receive a gift for these loan types. For instance, if the appraised value is lower than the purchase price or funds are needed for closing costs.
US Department of Agriculture Rural Development (USDA RD) loans allow the use of gift funds to be used to cover any down payment required or closing costs not already covered by the seller. Likewise, Veteran’s Administration (VA) loans allow gifts. For both of these programs, follow the same donor guidelines and documentation procedures as for conventional loans.
Typically, donors of financial gifts toward purchasing a house need to be relatives. According to Fannie Mae’s underwriting guide, a giftor can be “a relative, defined as the borrower’s spouse, child, or another dependent, or by any other individual who is related to the borrower by blood, marriage, adoption, or legal guardianship.” In addition, a fiancé or domestic partner can give a gift.
FHA expands the rules a bit, allowing an employer, charitable organization or government agency to contribute. There’s even a provision for a friend to give a gift, provided a documented, long-term relationship was in existence prior to the real estate transaction. An example would be a high school yearbook, a family photo album, or proof of being roommates in college. This is the kind of real-life documentation the underwriter might ask for when receiving a financial gift from a friend.
Whether it be a conventional or FHA loan you are qualifying for, the most important thing lenders want to know is that it’s a legitimate gift. No side arrangements between the donor and receiver to pay back the loan. If it’s truly a loan, the payments need to be included in the borrower’s debt ratio calculation.
Nor can gifts come from anyone who would benefit from the sale of the home – the seller, agents, loan officer, etc. – even if any of those individuals are related to the buyer. Any sums of money received from anyone involved in the transaction are subject to the limits of “interested party contributions” as designated by the loan program. These funds could not be used for down payment, but closing costs only.
For instance, FHA allows a maximum of 6% of the sales price in interested party contributions. These funds can only be applied to closing costs. Conventional financing allows:
- 3% contribution with a down payment of less than 10%.
- 6% contribution with a down payment between 10% – 25%
- 9% interested contribution for closing costs for down payments over 25%
Again, these funds can only be applied to closing costs, not the down payment.
A gift letter form will need to be provided along with any gifts received. This letter will be signed by the donor, and state that the money is to be used for the sole purpose of purchasing a home, and that there is absolutely no expectation of repayment. The letter will include items like the donor’s name, address, phone number, bank account number, and relationship to the homebuyer.
The loan officer usually provides a template gift letter for the borrower to provide to the donor. The donor then completes and signs the letter.
Show Me the Money
Another piece of documentation is the source of the funds. “Sourcing” funds, as it’s called within the mortgage industry, means showing proof of where the money came from. When dealing with gift funds, “sourcing” gift funds means providing a bank statement showing that the donor does in fact have enough money to give.
This is where things can get a bit sticky. Often, the mortgage lender requires the donor to hand over a full copy of his or her bank statements, showing all transactions and personal information. Many donors don’t exactly enjoy handing over personal information for a loan that’s not even theirs. Anyone receiving a gift should let the donor know up front about this requirement.
Next, a “paper trail” needs to be established. A paper trail is a set of documents that follow the money. The paper trail would include
- A bank statement showing the gift money came out of the donor’s account,
- A withdrawal receipt from the donor
- A deposit receipt from the receiver
- A statement from the receiver’s bank showing the money is now credited to his or her account
Then the receiver will have to show proof of the gift money coming out and a receipt from escrow showing the funds were received.
Some steps can be cut out if the donor wires the gift money directly to the escrow company handling the transaction. In that case, all that would be needed is the donor’s bank statement, and a receipt from escrow.
Likewise, if gift funds were received a long time ago, documenting it may not be necessary. The mortgage lender considers the funds yours if you can show bank statements that 1) do not show the initial deposit, and; 2) show the amount has been in your account for 60 days. The gift money would then be considered “seasoned,” which means they have been in your possession long enough to be considered yours.
Conventional loans allow for a gift type called a “gift of equity.” A gift of equity can be given when the seller of the home sells the property to a family member. The seller literally gives a portion of their equity to the buyer. This equity is used as the buyer’s down payment in lieu of cash.
For this to work, the current owner must be an eligible donor as per conventional loan gift guidelines, and must own and have equity in a piece of property.
As an example, if your parents own a second home worth $100,000, they could sell the home to you and give you $20,000 in equity. You could open a conventional loan for only $80,000 to buy the property. This 20% in gift equity would count as your down payment. The final sale paperwork would say that the home sold for $100,000, but only $80,000 would be required to pass from the buyer to seller.
Keep in mind that the home would have to appraise for $100,000 in this case. The donor of gift equity would need to complete and sign the gift letter, just as if the gift were given in monetary funds.
As far as the paper trail, the lender will accept the final settlement statement, also called the final HUD-1. The final HUD-1 statement is provided by the escrow company, and displays each fee that’s related to the property sale transaction. The HUD-1 will show the gift by showing an item stating “Gift of Equity – $20,000,” or something to that effect. This is proof that the intangible equity has been transferred from the seller to the buyer.
The gift of equity may appear to fall within the definition of an interested party contribution, since it’s the seller who is giving the gift. However, Fannie Mae and Freddie Mac make this situation exempt from interested party contribution rules when the buyer and seller have an eligible relationship.
Receiving Gift Funds Is Well Worth the Effort
Although receiving and documenting financial gifts for down payment can be cumbersome, it can be well worth it. For many first time home buyers, it can mean the difference between buying a home now, or buying years from now.
Receiving a gift reduces the amount of savings needed to close the purchase transaction and also lowers the payment on the future mortgage. With a little education on the gifting process and a willing donor, receiving a gift to be applied toward the down payment on a house can turn out to be a very sweet deal for the first time home buyer.