Maybe it’s money your grandma has tucked away for the day you decide to buy your first house. Or maybe it’s wedding card envelopes stuffed with cash. Either way, receiving presents in the form of funds to put toward a down payment can take a huge burden off your shoulders when you’re looking to start the home buying process.
What Qualifies As A Down Payment Gift?
You might assume that you can just use whatever financial gifts your loved ones give you for a down payment, but using gift money is not as cut-and-dried as you might think. Whether you have $20 or $20,000, the source of the funds in your bank account will matter just as much as how much money you actually have.
To understand why the source of your funds matters to your mortgage company, you’ll first need to understand what underwriting is and how it impacts your loan.
Understanding Underwriting
Underwriting refers to the process in which your lender looks at your credit score, income and assets to determine how risky it would be to lend you money. When underwriters look at your assets, they check to make sure that the money in your account is indeed your money – they want to make sure any large deposits (other than something regular, such as your paycheck) are your actual assets. This includes confirming that any deposits in your account from friends and family that you plan to use for a down payment are gifts, not loans.
This is essential to ensuring that you can actually afford your mortgage payment, and that you’ll be likely to pay the loan back. If you used a personal loan to qualify for a home loan, chances are you’d be left with a big financial mess once you had to start paying both loans back.
So, how can an underwriter establish that deposits in your bank account are gifts and not loans? Let’s dive a little deeper into the concept of gift money, how it can be used in a real estate transaction and the effect it can have on your finances during the underwriting process and over the course of your home buying journey.
Types Of Down Payment Gifts
There are two types of gifts that your relatives or contacts can provide: a cash down payment gift or, in the event a family member is selling the property to you, a gift of equity. In each case, the funds may be used for the down payment, closing costs and prepaid interest points.
Depending on the type of loan, you may also be able to use the gift to pay off debts so you can qualify for your mortgage. In certain situations, a home buyer must have a certain amount of payment coming from their own funds:
- A 5% contribution is required for conventional loans for second homes and multi-unit properties if the down payment is less than 20%.
- There’s a required 5% contribution from borrowers on all jumbo loans.
- If your credit score is between 580 and 619, 3.5% of your FHA down payment must come from your personal funds.
Cash Down Payment Gifts
A cash down payment gift is straightforward. You get money from a gift giver – oftentimes a family member – and use it toward your down payment and costs. There are a couple of things your lender will need from you to use the gift:
- A gift letter (a written statement that includes, among other things, the amount of the gift and confirmation that it doesn’t have to be paid back)
- Evidence of the transfer of funds
You can show evidence of the transfer with the donor’s withdrawal slip and your deposit slip, or a copy of the check and evidence that it’s been deposited into your account. If the gift is made at closing, there must be a copy of the donor’s certified check and a settlement statement with the exact amount of the gift. If the donor borrowed the funds, they need to be able to document the source. The gift cannot come from cash the donor has on hand.
Gifts Of Equity
While gifts of equity are not technically cash deposits, they can be helpful tools in acquiring real estate. A gift of equity occurs when someone (usually required to be a family member) sells you a property for below the sale price.
The difference between the price you pay and the listed price is considered an amount of equity to be used toward your down payment, or to help pay off debt to qualify. It can also be used toward your points and closing costs.
To use the gift of equity, a home buyer must include a gift letter, just as if they were being given a cash down payment. Minimum contribution requirements still apply as well.
On FHA loans, a client can also get a gift of equity from a nonprofit agency or his or her in-laws.
Gifts of equity are not allowed on VA and jumbo loans.
Underwriting, Gift Money And Gift Letters: Timing And Amount Are Key
While gifts of equity can be valuable contributions to those trying to buy a home, we’re going to focus more on gift money for down payments and the role it can play in the mortgage underwriting process.
Say you’ve just gotten married and received a chunk of money to put toward your down payment. While you may be excited to get that cash in the bank, you don’t want these deposits to cause problems when you’re trying to qualify for a mortgage.
As the underwriter begins to review your finances, there are two important factors at play with regard to the influence your gift money can have on the process: the timing of when you received the gift money, and the amount of gift money needing to be formally verified through gift letters.
Let’s expand on how gift money impacts underwriting.
Timing Of Gift Money Being Received
Asset verification is an important component of the underwriting process, and different lenders can have different requirements for the kinds of materials needed from prospective borrowers to verify the sources of wealth being used to back their real estate purchase. Rocket Mortgage®, for example, requires a 60-day history of assets for qualification purposes.
If you’re able to provide your underwriter with sufficient documentation to prove that the gift money you received was recently accounted for among your assets, you should be able to put the funds toward your down payment without issue.
Amount Of Gift Money Up For Review
So, within that asset history time frame established by your lender, which deposits do you have to worry about getting a gift letter for? Grab your wedding veil and jump into this hypothetical situation with us for a moment.
You just got married. Aunt Sue gave you a $75 check, but Grandma Betty gave you $10,000. Will you need gift letters for both deposits?
In general, your underwriter will need to verify the source of any large deposit. What’s the criteria for a “large deposit,” you ask? It’s any single deposit that exceeds 50% of the total monthly qualifying income. This is for conventional, VA and jumbo loans. For FHA and USDA loans, a large deposit is defined as any deposit that is greater than 1% of the adjusted purchase price or appraised value, whichever is lower.
Let’s say you’re doing a conventional loan for our example. If you make $4,000 a month, any deposit over $2,000 would probably be questioned by your underwriter. Therefore, the underwriter will probably want to verify that Grandma Betty’s $10,000 gift is a gift, not a loan, so you’ll need to ask her for a gift letter. Aunt Sue’s gift, however, is small enough that the underwriter might not question it.
Of course, this is partially up to the underwriter’s discretion. If there are any deposits that seem to be out of the ordinary, your underwriter may question them regardless of your income. If you normally had $2,000 in your checking account and you suddenly have a deposit for an extra $8,000, they would want to verify that regardless of the purchase price/appraised value or qualifying income.
Your lender would dig deeper into that situation to make sure the situation checks out. While your Aunt Sue’s small gift might not be questionable in itself, if the underwriter finds that it’s out of the ordinary, they may require gift documentation.
Who Can Gift Money For Mortgage Down Payments? Guidelines Based On Loan Type
Depending on the type of loan you’re getting, there are differing guidelines regarding who may give a down payment gift to you. Let’s briefly go over those.
Conventional Loans
If you’re getting a conventional loan through Fannie Mae or Freddie Mac, the gift has to come from family. For the purposes of your mortgage, family is defined as follows:
- Spouse
- Parent (including step- and foster)
- Grandparent (including great-, step- and foster)
- Aunt/uncle (including great- and step-)
- Niece/nephew (including step-)
- Cousin (including step- and adopted)
- In-laws (including parents, grandparents, aunt/uncle, brother- and sister-in-law)
- Child (including step-, foster and adopted)
- Sibling (including step-, foster and adopted)
- Domestic partner
- Fiancé
If you happen to get a loan from Fannie Mae, they also allow gifts from future in-laws.
FHA Loans
With FHA loans, nearly all of the above are considered family who can give you a gift, including future in-laws. However, some caveats apply.
While cousins, nieces and nephews aren’t able to give your gift under normal family guidelines with an FHA loan, the FHA does allow for gifts from close friends who have a clear interest in your life. This can include extended family like cousins, nieces and nephews and even former spouses.
In addition to the close friend guideline, the FHA also allows for gifts from the following:
- Employer
- Labor union
- Charitable organization
Finally, you can receive funds from a government agency or public entity that provides homeownership assistance to low-to-moderate-income or first-time home buyers.
USDA And VA Loans
The USDA and VA don’t place very many restrictions on who can give you a gift. The only stipulation is that it can’t be an interested party. An interested party is someone who is involved in the transaction directly or indirectly. This includes, but isn’t limited to:
- Seller
- Builder
- Developer
- Real estate agent or REALTOR®
Are There Restrictions On How Gift Funds Can Be Used?
There are no limits on the amount someone can give you for a mortgage down payment or closing costs. However, depending on the loan and property type, you may be required to contribute a certain percentage of the down payment from your own funds.
Keep in mind that these rules are subject to change based on lending regulations, so you should check with your mortgage company for up-to-date guidelines.
Primary Residences
If you’re getting a primary residence, you can use gift funds for your down payment. These guidelines apply:
- If it’s a single-family home, you can use gift funds without having to contribute any of your own money to your down payment.
- If it’s a multifamily home, you can get a home without having to contribute to the down payment as long as the down payment is 20% or more. If your down payment is 20% or less on a multi-unit home, you have to contribute at least 5% of your own funds to your down payment.
Second Homes
If you’re getting a second home through a conventional loan (you can’t get them through the FHA, USDA or VA), the following guidelines apply regarding gift limits:
- If you’re making a down payment of 20% or more, all funding for the down payment can come from the gift.
- If it’s less than 20%, then 5% of your down payment must come from your own funds.
Investment Properties
Gift funds cannot be used toward the down payment on an investment property. In most cases, if you’re looking to purchase real estate to make money off of the property, you’ll need to use your own funds to cover the down payment.
What Are The Tax Implications Of Down Payment Gifts?
Tax laws change on a fairly regular basis, and you should always speak with your financial advisor or tax professional in order to make sure you’re in compliance with the most current law.
In general, you won’t be responsible for any taxes on gift funds. Your donor may be, however, and it might be helpful for you to make sure they’re aware of that. The only occasion where you’d be expected to pay the gift tax would be if you’d agreed to pay it for the donor.
For 2021, the annual exclusion for gifts is $15,000, meaning donors can give up to this amount without having to report it.
If your donor gives you more than that amount, they’ll have to file a gift tax return to disclose the gift. Filing a return doesn’t mean that they’ll have to pay taxes on the gift, it just means that the amount has been counted toward their lifetime gift tax exclusion, which dictates how much money you can gift a person over the course of your lifetime.
The Bottom Line
If you know that you’ll be getting any financial gift to help with your down payment, be prepared to document it for your mortgage company. Do you still have questions about using gift money for your down payment? Get started online, or give us a call at (800) 785-4788 to speak with one of our Home Loan Experts!
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