When applying for a mortgage, buyers need to consider the type of loan programs available as well as the down payment requirements for each program.
In addition, borrowers will need additional funds to pay for closing costs associated with getting a mortgage. Borrowers can use their own funds such as a checking or savings account, a grant or retirement and investment accounts. Sometimes though they’re just not quite there with enough funds or they want to get a financial gift to help out with some or all of the costs involved.
What are the rules for down payment and closing cost gifts and are there any income tax considerations?
What Is a Financial Gift?
That might seem a silly question but a gift needs to be identified, explained and documented. A gift is a financial amount from one party to another to be used to help with all or part of the desired down payment. A gift is not a loan. It is not expected to be paid back. But it also has to be documented. There is a standard form that lenders use called a Gift Affidavit which details who the donor will be, where the funds will come from and the lender can make the determination the donor can afford the financial award with no negative impact on the donor’s finances. In short, lenders will make sure the funds are coming from a lawful source and not a loan which would require an additional lien to be filed. There are ways to avoid this documentation process as we will explain later.
The Process
Along with the gift affidavit, the transfer of the funds must be clearly documented. This means a withdrawal notice or statement from the donor’s account showing the amount being transferred. The gift will then be deposited in the buyer’s account. If the gift comes in the form of a check, the buyers should be prepared to provide a front and back copy of the cancelled check along with a copy of the deposit receipt.
In order to bypass this paperwork process, the donors can simply wire the necessary funds directly to the settlement agent and not to the buyers. The settlement papers will show the fund transfer.
Don’t be surprised if your lender questions you about a certain deposit in your bank account, even if the funds are not a gift. For example, you get paid on the 1st and 15th for the very same $3,200 amount. You pay check stubs back that up. But on the 23rd there is a lone deposit of $2,300. Where did it come from? If you intend to use this $2,300 for closing costs you’ll need to convince the lender the $2,300 is a gift and document the transfer or the amount came from a legitimate source such as the sale of an asset. In this example, you sold an old automobile and can document the sale. Otherwise, without documentation, the lender won’t allow you to use this additional $2,300.
Okay, so how can you avoid all this paper trail? By simply having the donor wire the necessary funds directly to escrow and avoid the process of collecting bank statements from the donor as well as the borrowers and tracking the cash movements. Lenders simply must follow proper guidelines and it’s much easier to have the funds transferred not to the borrowers but to escrow.
How Much?
How much can you get as a gift? Well, you can get the entire transaction as a gift but that’s rare. But there are restrictions on how much you can receive along with how much you need to have of your own funds in the transaction. The entire amount needed for closing can be a gift. You won’t need any funds of your own verified.
If the gift isn’t enough to cover what you’ll need, you can expect to provide copies of your most recent banks statements showing evidence of sufficient cash to close.
For an FHA loan, all of the down payment can be in the form of a gift as well as a gift to be used for closing costs. VA loans don’t require a down payment but do allow a gift for closing costs as well.
Jumbo loans, those loan amounts greater than the conforming minimum, typically have down payment requirements of at least 20% of the sales price and can be in the form of a gift. Most jumbo loan programs do ask for a portion of the funds needed to close coming from the borrowers account in the even of a gift if the gift is less than 20%, the buyers must have 5.0% of their own funds in the transaction.
However, we do have select jumbo loan programs that have no such requirement and the entire cash to close needed can be in the form of a financial gift. Different loan programs can have different requirements but in general this is the case.
Who Can Give a Gift?
Only specific parties are allowed to provide a gift. This can be a blood relative such as an uncle or parent or grandparent. If you’re engaged, your fiancé can provide a gift. Domestic partners can be a donor. Some employers have special programs that give financial awards to employees in order to buy a home, so too do some labor unions. Someone who is considered a close friend with a “clearly defined and documented interest in the borrower” qualifies as well as do non-profit organizations.
City, county and state organizations can also provide financial assistance in the form of a grant. Most grants are issued and after three years do not have to be paid back and are for all practical purposes a gift.
Gift of Equity
What is a gift of equity? A gift of equity is a portion of the equity resulting in the sale of a home and transferred to the buyer to be used as closing in lieu of cash or the seller to wire any funds to the escrow agent. Instead, the equity being transferred is shown on the settlement statement.
For example, a couple is selling their home and will net $250,000. They decide to provide a gift of equity of $50,000 to help the buyers buy the home. The escrow agent notes the transfer as a buyer credit on the settlement statement. A gift of equity can only be used in the transfer of a primary residence or second home purchase transaction.
Your loan officer can review the requirements when you receive a gift but in general if up to 100% of what you will need to close can be in the form of a gift. The only difference may be the degree of documentation as it relates to the transfer.
