Buying a home can be a serious challenge. There’s a ton of preparation required, a lengthy and hyper-involved process, and a seemingly endless sum of associated costs. While there’s no opting out of any of the previously mentioned home buying pitfalls, the one that most buyers tend to fear the most is the cost of buying a home.
Throughout the transaction, there’s a ton of costs and fees that pop up that require some out of pocket money. These include getting a home appraisal, a title search, and a home inspection. Luckily, most of these fees are paid as a part of the closing costs of the transaction.
Of the associated costs and fees that the average home buyer runs into, there is usually none more concerning than the down payment you’ll need to get a mortgage. As many homeowners can tell you, saving up the money for a down payment on a new home be a tough feat. That’s the case whether you’re just trying to hit the 3.5% required for an FHA loan, let alone the 20% expected of conventional mortgages. What plenty of home buyers don’t know, however, is that in most cases, money “gifted” from a third party is an acceptable source for a down payment on a home.
Still, that’s not to say that a home buyer can just source the amount they need from any old place (like a freshly robbed bank, for example) and claim it is a gift. There are rules to accepting gift money meant to be used towards a down payment or closing costs, and they must be followed in order for the entire mortgage transaction to be legitimate. If you’re shopping for a new home and intend to use gift money to cover closing costs or a down payment, this page is for you.
The Use of Gift Money in a Mortgage Transaction
It isn’t uncommon for home buyers to fret over how to come up with the money for closing costs or a down payment. This is especially true of first time home buyers, who can’t rely on the proceeds of a home sale as a source of funding. In today’s economy, not many people have a reliable source of saving to draw from when it comes to the financing of large purchases like a home or a car.
In this situation, some even give up on the dream of owning a home simply because they can’t fathom how to afford the upfront or out of pocket costs of getting a mortgage. It begs the question: How do some home buyers pull through and get their mortgages? The answer is actually quite simple.
As it turns out, many mortgage programs allow home buyers to use money gifted to them by a family member as funding for a down payment or as payment for part of their closing costs. In fact, gift money is typically allowed for conventional loans, FHA loans, USDA loans, and even VA loans. As you might imagine, this is quite the lifesaver for those lucky enough to have someone willing to front the funding for any part of a home purchase. While there are some restrictions and requirements, it’s becoming increasingly more common for borrowers to use gift money as a means to handle some of the more cumbersome out-of-pocket expenses associated with buying a home. This is especially the case among first time home buyers.
While mortgage programs allow home buyers to use gift money from a family member in some way, each has their own rules and regulations. It’s important to keep this in mind if you intend to use gift money when buying a home. Every home loan program is different, and planning ahead is guaranteed to help you get the most out of whatever gift money you’re fortunate enough to receive.
Who can Donate Money Towards a Home Purchase?
One of the major rules concerning gift money for a home purchase revolves around who the money is coming from. First and foremost, no party with a profitable interest from the home sale is allowed to provide the gift money. With that out of the way, there is still a strict requirement to be mindful of.
For the vast majority of loan programs, gift money is only allowed to come from a family member of the home buyer. To define the appropriate and acceptable relationships for gifting money, Fannie Mae’s underwriting guide states that 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 fiance or domestic partner is also acceptable to provide the gift. Proof of relationship to the home buyer is usually required along with a gift letter.
Gift Letters for Mortgage Transactions
When using gifted money in a mortgage transaction, you can’t just show up with a sack of cash, claim that it’s from your third cousin’s mother’s aunt's sister-in-law’s nephew (twice removed), and expect to be good to go. The important thing to remember is that your out of pocket expenses, the down payment in particular, serve more than the simple purpose of covering fees. In fact, lenders also expect an investment on the borrower’s end to show reasonable commitment to the repayment of a loan.
If you show up empty-handed, it doesn’t really reassure your lender that you’re a trustworthy individual. This is what makes the down payment so important, as it demonstrates your willingness to invest in the home purchase. Remember that there are hardly any 100% loan-to-value mortgages on the market (aside from VA loans and some USDA loans), as the average required investment for a mortgage is an industry standard of at least 20%.
This means that the borrower is expected to have that amount ready at closing at the very least, unless the loan program has a different required down payment amount, such as with an FHA loan. If a home buyer personally couldn’t come up with the money and had to use money that was gifted to them, then the lender needs to know just where this money is coming from. They’ll also want to know whether or not it is a loan or an actual gift. This is where gift letters come in.
A gift letter’s purpose is simple. Gift letters serve as an official document signed by the donor of the gift money that acknowledges the borrower as the recipient. Gift letters also contain a stipulation that no repayment of the donated “gift” is expected. Through a gift letter, lenders have documented proof that the money in question was granted to the borrower to be used at their discretion, not loaned to them.
Another function of gift letters is to provide a paper trail. During a mortgage transaction, large sums of money will be trading hands, and it’s expected that a singular bank account be used to handle all monetary matters throughout and at the closing of the mortgage process. It’s also important that no other major transactions or changes to the account take place during this time, as it could greatly jeopardize the approval of a mortgage.
Since a home buyer’s bank account is under such heavy scrutiny, a random injection of money with no explanation could actually negatively affect the mortgage transaction. With a gift letter (along with the intent to put the deposited money towards a down payment or closing costs), the lender can be aware that it is a documented sum of money to be used as part of the home purchase.
Preparing a Gift Letter
Seeing as how one little misstep can cost a home buyer a mortgage approval, it’s essential that the proper steps be taken in order to successfully utilize gift money for a home purchase. As the person gifting the money, all the good intentions in the world can’t change a denial due to a lack of a legitimate gift letter.
That said, there’s nothing overly complicated about drafting a gift letter. In fact, many websites like mymortgageinsider.com even offer downloadable gift letter templates that simply require the donor to fill in or edit some fields and sign. Still, gift letters can be written from scratch.
Remember that the entire purpose of the gift letter is to prove that the money is being given to the home buyer with no expectation of return. As such, an acceptable gift letter should contain all of the following:
The donor’s name, address, and phone number
The donor’s relationship to the recipient (MUST be a family member)
The exact dollar amount of the money being gifted
The transfer date of the gift money to the recipient
A statement from the donor that clearly specifies that the gifted money is NOT to be repaid
A signature and date
The name and phone number of the recipient
The address of the home being purchased
A detailed gift letter provides all of the necessary information that a lender requires for the donation to be approved and used as intended in the transaction. Even so, it’s highly recommended that the donor also include a bank statement showing the money as it was in the account, as well as all relevant documentation that shows the transfer of the money to the recipient.
Documenting Gift Money for a Mortgage Transaction
As we mentioned before, lenders are pretty obsessed with keeping track of the source and flow of a home buyer’s money during a mortgage transaction. When gift money is added into the mix, it becomes even more important for there to be an easily followed paper trail. Having an acceptable gift letter is only a part of the documentation needed.
Providing the appropriate documentation is the only way to ensure that the mortgage transaction continues moving smoothly. This means handing over bank statements, and not just from the home buyer, either. One major point of contention for donors of gift money is that they too must submit their bank statements to the mortgage lender.
A good paper trail should consist of:
The donor’s bank statement for the account that the money is coming from
While not normally specified by any lenders, we recommend two bank statements. One that shows the account balance BEFORE the money was withdrawn or transferred, and one that shows the account balance AFTER the gift money was withdrawn or transferred.
A withdrawal or transfer/wire receipt from the donor showing the date the money was moved as well as the account it was moved to (in the case of a transfer or wire)
A deposit receipt from the recipient’s bank account
The recipient’s bank statement showing the account that now holds the gift money
The receiver must also produce the appropriate documentation for the escrow account designated for the transaction once the money is utilized
Must have a bank statement showing the transfer of money into the escrow account
Must have a receipt from the escrow account that shows the money was received
As long as the money can be properly tracked and accounted for along the way, there should be no hold ups in the mortgage process. If the money was gifted long before the transaction was ever initiated, borrowers typically don’t have to worry about a paper trail, as long as bank statements can be provided that show that the money was left untouched in the home buyer’s account for at least 60 days prior to the transaction.
Utilizing Gift Money for a Conventional Loan
Conventional loans may very well be the most widely used mortgage packages in the country. Conforming to standards set by Fannie Mae and Freddie Mac, these loans vary by lender, and have no government insurance, meaning that they have stricter eligibility requirements. On top of that, they generally require down payments of at least 20% of the home’s purchase price.
Even so, conventional loans are typically known to allow home buyers to use gift money towards down payments, fees and even closing costs. In the past, borrowers still had to make at least a 5% investment from their own pockets, but that rule has been modified in recent times. The stipulations for needing a 5% investment from the borrower when utilizing gift money for a conventional mortgage are:
If the loan amount exceeds the national conforming limit of $453,100
If the gift amount is less than 20% of the purchase price of the home
If the property being purchased is a duplex, triplex, or four-plex
While it may seem a bit confusing at first, your initial understanding is correct. The borrower doesn’t need to add any money out of pocket if the gift amount covers the entire 20% of the home purchase price.
Utilizing Gift Money for an FHA Loan
Boasting one of the lowest possible down payment requirements of all of the mortgage options on the market, FHA loans are some of the most popular mortgage products among first time home buyers and repeat home buyers alike. With so many additional benefits for home buyers including competitive interest rates, 15 and 30-year loan term options, and flexible eligibility requirements, it’s hard to believe they can offer anything more. Yet they still included the option for home buyers to utilize money received as a gift to help with the down payment on a home.
As if that weren’t enough, there is no restriction on how much of the down payment can be covered by the gift money. In an even more mind blowing move, the FHA allows home buyers to cover the entire 3.5% minimum investment using gift money. That would leave the borrower only responsible for remaining closing costs as out of pocket expenses!
Utilizing Gift Money for a VA or USDA Loan
Of all of the mortgage options available, only loans insured by the VA and a few backed by the USDA have down payment requirements of 0%. Of course, these loans are reserved for either veterans (in the case of VA loans), or residents of rural and low-income areas (for USDA loans). With the burden of a down payment removed from the equation, surely there couldn’t be an allowance for using gift money to cover closing costs, right?
Wrong. They absolutely allow it. However, the general guidelines for accepting and using gift money still apply to USDA and VA loans. Gift money for USDA loans can be used for any down payment amount or closing costs not covered by the seller. And, for VA loans, gift money can be used across the board!