Giving a gift of equity to a loved one should be a simple process, but with real estate regulations and tax laws, it can become rather complicated.
Let’s look at a few of the details behind gifts of equity so you can make the right decisions for your financial future.
Gift of Equity: Understand the Process
What is “Gift of Equity”
The term “gift equity” essentially refers to a gift that is provided by the seller of a specific property to the buyer. This gift is a portion of the seller’s equity, and it goes to the buyer as credit during the purchase. Gift equity has some specific rules and regulations, but it is permitted for both primary residences and second-home purchases. There are, however, specific donor requirements and mandatory borrower contributions for gift equity.
Gifts of equity are generally given from one family member or loved one to another, allowing the buyer to make a purchase of the home at a significantly-reduced price. The amount of the gift is usually the difference between the market value of the property and the sale price.
Let’s say Uncle Roy has a beach house worth $2 million that he sells to you for $1.5 million.
In this case, the “gift of equity” is $500,000:
$2 million (Appraised Value)
-$1.5 million (Sale Price)
$500,000 (Gift of Equity)
Why is Gift of Equity a Concern?
It seems like giving a gift to a loved one should be simple, but there are tax implications and loan considerations for large financial gifts. As far as taxes, giving a large sum of money, even in the form of home equity, can create a large tax hit. Therefore, both the buyer and the seller should meet with a qualified tax attorney. For mortgages, lenders want to see that the person receiving the equity gift and taking out a mortgage for the remainder will be able to pay back the loan.
The Federal Housing Administration has guidelines for acceptable sources of borrower funds, and there are legal processes that both parties must complete for th lenders to issue the loan.
Required Documents
First of all, both parties must bring specific required documents. This includes a signed letter from the seller that verifies the donor’s name, address and telephone number. The letter must speak to the relationship between the buyer and seller, and include the amount of financial value (the gift of equity total) included in the gift. It must also state that no repayment from the buyer will be required; in other words, it needs to confirm, in legal writing, that it is in fact a gift and not a loan.
If the gift is from a relative or domestic partner and it’s being added to the borrower’s funds, then certain documents must also be included. If domestic partners, there should be a certificate from the donor stating that the borrower and donor have lived together for the past year and will continue to live together. There should also be documents verifying that both people have lived together. The donor’s address will have to be the same, and this can be verified with a driver’s license, utility bill, bank statement, or another type of document.
Using Gift Funds
If you are going to use a mortgage to fund the rest of the transaction, you may use funds received as a gift to pay for the down payment, closing costs, or to secure financial reserves.
Acceptable Donors
You have to have a specific relationship with the donor in order to use a gift of equity when securing a mortgage loan. The gift can be provided by a dependent, which can include the borrower’s child or spouse. It can also include people related to the borrower by blood, marriage, or adoption. The transaction can also include fiancés or domestic partners.
The donor may not, however, have a relationship or affiliation with the builder, developer, real estate agent, or any other party that may have a financial interest in the home purchase.
Borrower Contributions: The Minimum
For loan-to-value ratios of 80% or less, a minimum borrower contribution from personal funds is not required, and all the funds required to complete the purchase can come solely from the gift. If the loan-to-value ratio is greater than 80%, and the property is a one-unit principle residence, then a minimum borrower contribution is also not required and all the funds can come entirely from the gift.
However, if the loan-to-value is greater than 80%, and the property is a two to four-unit principle residence or second home, then the borrower will be required to contribute 5% from their own personal funds. Once the minimum contribution has been met, the gift of equity can be used to pay for closing costs, support reserves, or fund the down payment.
Fund Verification
The funds provided by the donor will eventually need to be verified. To verify the funds, a lender will need to see proof that there are enough funds to cover the gift and that the funds are either in the donor’s bank account or have already been transferred to the borrower.
Verification can come in many forms, including a copy of the donor’s check and the deposit slip or a copy of the withdrawal slip with the deposit slip. You can also use a copy of the donor’s check to the closing agent or a statement that shows the donor’s check has been received.
If the funds have not been transferred before settlement of the purchase, the lender will need to document that the donor has given the closing agent gift funds in a certified check, cashier’s check, or another type of official check.
Common-Sense Lending for Gift of Equity Purchases
If you are giving or receiving a gift of equity, make sure you have reliable legal and tax advice. You’ll also need support from an experienced lending professional.
Contact San Diego Purchase Loans today and we’ll help you find the right lending options for your specific needs. From first homes to luxury vacation houses, we are here for all of your real estate needs!
