The lowdown on gift funds
Saving for a down payment can seem like an impossible task—especially if you’re a first-time homebuyer. Between not having enough savings to fall back on and maintaining your current bills, it can take years to save up a substantial amount.
To expedite the process, many people end up enlisting the help of family members and use what is referred to as a gift fund, or a gift of equity. And while it may seem simple—you got gift money from a family member to use on your down payment for a home and you’re going to use it—there are a few rules and regulations to follow.
Here we outline all the details you need to know.
Make it clear there are no strings attached
Gift funds are closely regulated by lenders, as they want to ensure a gift is really just that—a gift, not a loan. If it’s money that needs to be paid back, which would be considered debt, it can drastically change the debt-to-income ratio lenders rely on when assessing a potential borrower’s finances.
Because of this, only certain people are allowed to “gift” a down payment. This list varies depending on the type of loan, but in all instances should reflect a close relationship to the buyer.
Gift guidelines for relationship to buyer for conventional loans:
- Immediate family members, including parents, grandparents, siblings and spouses
- Soon-to-be-family members, including domestic partners and engaged couples
- Governmental agency or public entity with homeownership-assistance program
Gift guidelines for relationship to buyer for FHA loans:
- Family members
- Friends with clearly defined/documented interest in borrower
- Employer or labor union
- Charitable organization
- Governmental agency or public entity with homeownership-assistance program
The off-limits list:
Anyone with a vested interest in the sale of the house is excluded from being able to assist with a buyer’s down payment, which includes the following individuals:
- Seller
- Real estate agent from either side of the potential sale
- Builder
Documenting your gift
Any gift funds, or gifts of equity, must be reflected on the Uniform Loan Application Form (Form 1003). Typically, borrowers will include a letter from the person who provided the gift money, stating that it does not need to be paid back, while including personal information, such as name, address and contact info. A lender will also need to see a paper trail that shows the money leaving and entering its respective accounts.
Specifics for wedding gifts
A wedding can be an instance where you’re not necessarily receiving one lump sum from one individual to use for a down payment, but rather, several gifts from several attendees that you might want to pool together to put towards a down payment.
You might find yourself depositing checks that range from $50 to thousands of dollars, equaling a larger sum of money that you’d need to document, but that doesn’t mean you have to document each individual check.
Documenting wedding gifts work slightly differently, the first difference being that the relationship between the gift giver and the gift receiver does not need to be explained, nor does the gift giver need to meet particular specifications, such as being a family member, etc.
What does need to be provided, is a copy of the marriage license and verification of the funds into the borrower’s account. The gift funds also need to be deposited within 90 days of the date of the marriage license.
The limits
Exactly how much gift money a borrower can use as a down payment depends on the type of loan and the percentage of money they’ll be putting down on their home. With an FHA loan, an entire down payment can come in the form of a gift, whereas a conventional loan depends on the percentage of the down payment.
Conventional loan specifications
If a borrower is using gift money and putting down less than 20% for a conventional loan, some of that money will need to come out of the borrower’s pocket. The exact amount will be determined by the investor who owns the loan and the company providing the Private Mortgage Insurance (PMI), which is required for borrowers who put down less than 20% on their new home. PMI can later be eliminated on some loans, once a borrower reaches the 20% threshold of built-up equity on their home.
On the other hand, if a gift fund covers 20% or more of the home to be purchased, the entire down payment can be covered through a gift for a conventional loan as well.
Regardless of the type of loan, gift money can be used to purchase a primary residence or a second home but cannot be used to buy an investment property.
Ready for underwriting
Following these guidelines can help you avoid potential headaches that can pop up in the underwriting portion of your loan—the point in time where a lender is verifying your credit score, income and assets. They’re looking to ensure any large deposits (besides a regularly occurring paycheck, etc.) are real assets and not borrowed money.
So, whether you’ve just gotten married (congratulations), or your mother-in-law is dropping some major hints that she wants to be a grandmother—offering to cover your down payment so that you can buy that home with an extra bedroom—just make sure to document any gifts accordingly. Work with your mortgage team to ensure your file is fully prepared for underwriting.