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20% Down Alternatives: Using Gift Money

Photo by Katie Harp on Unsplash

For many New Yorkers—particularly Xers and Millennials—the path to home ownership often involves gift money for that 20% down payment. If that’s not you, we get it (trust us), and we’ll be covering alternatives in the next few articles because you’re far from alone. For those who do have access to gift money, it can remove a huge burden from your shoulders on your home-buying journey. But cash, no matter how fortuitous, is not as straightforward a gift as it may seem. That’s because whether you’ve been gifted $2,000 or $200,000, it’s the source of the funds that is almost as significant to the process as the money itself.

To understand why the source of your funds is so important to your mortgage company, you’ll first need to understand the process of underwriting and how it impacts your loan. We’ll then cover some important things to know about receiving and using gift funds.

Let’s Look At the Gift Letter

If you’re using gift money as part or all of the down payment, you’ll need to ask the donor to write what’s called a “gift letter” to your mortgage company that makes it clear that the money is a gift and not a loan.

A gift letter should include:

  • The donor’s name, address, and phone number
  • The donor’s relationship to the client
  • The dollar amount of the gift
  • The date the funds were transferred
  • A statement from the donor that no repayment is expected
  • The donor’s signature
  • The address of the property being purchased

It’s important to understand that the gift letter itself may not be enough evidence for the mortgage company. Your lender will also want to verify that the funds are either in the donor’s account or have been transferred to the recipient’s. This is usually done by asking for copies of the withdrawal and deposit slips. This is something you’ll want to let your generous friend or relative know up front, so they’re prepared to provide the proper documentation.

Sample Gift Letter

Your lender may provide you with a gift letter template, which you can simply pass it along to the gift giver and have them fill it out. If they don’t provide you with a template, be sure to ask what their gift letter requirements are.

If you don’t have a template, here is an example of what your gift letter should look like:

[Donor name, address, phone number and relationship to recipient]

[Recipient name and new property address]

[Dollar amount of the donated gift and date the gift was or will be given]

[Indicate whether recipient will use (or has used) a portion of the gift for their earnest money deposit]

By signing this gift letter, both the donor and recipient confirm that they didn’t receive the gift funds from any person, business or entity that has any interest in the property being sold or any person connected to the transaction, such as the seller, real estate agent, builder, mortgage banker or any entity associated with them. The recipient and the donor also agree that the gift does not have to be repaid.

At the end of the letter, both the recipient and the donor should provide dated signatures.

Timing and Amount Are Key

Say you just got 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 if you’re trying to qualify for a mortgage. Let’s go over some further details on how gift money impacts underwriting.

Timing

Many mortgage brokerages require a 60-day history of assets for qualification purposes. So long as you have documentation for the past 60 days, your mortgage company can take it from there.

Amount

Looking at that 60-day period, the next step is to determine which deposits do you have to worry about getting a gift letter for. Hop into this hypothetical situation with us:

You just got married. Your aunt gave you a $75 check, but your grandma gave you $10,000 for tying the knot. Big difference, right? So do you need gift letters for both?

Typically, your underwriter will need to verify the source of any large deposit but it’s important to know what constitutes a “large deposit?” It’s any single deposit that exceeds 50% of the total monthly qualifying income (this applies to conventional, VA, and jumbo loans). FHA and USDA loans define a large deposit as any deposit that is greater than 1% of the adjusted purchase price or appraised value, whichever is lower.

Let’s imagine you’re applying for 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’s $10,000 gift is a gift, not a loan, so you’ll need to ask her for a gift letter. Your Aunt’s gift, however, is small enough that the underwriter will likely not question it.

Still, this is all 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. We would dig deeper into that situation, just to make sure the situation checks out. While a small gift might not be questionable in itself, if the underwriter finds that it’s out of the ordinary, he or she may require gift documentation.

Who Can Give Me a Down Payment Gift?

In addition to how much you’re gifted, 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 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 for gift-giving purposes, including future in-laws. Still, 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 home ownership assistance to low-to-moderate income or first-time home buyers.

USDA and VA Loans

These options don’t place as many restrictions on who can give you a gift. Their sole stipulation is that it can’t be an “interested” party. An interested party is considered anyone who is involved in the transaction directly or indirectly. This includes, but isn’t limited to:

  • Seller
  • Builder
  • Developer
  • Real estate agent

What Are the Gift Limits?

There are no limits on the amount someone can give you for a mortgage down payment or closing costs. Depending on the loan and property type though, you may be required to contribute a certain percentage of the down payment yourself.

These rules are subject to change based on lending regulations, so be sure to check with your mortgage company for up-to-date guidelines.

Primary Residences

If you’re buying 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 multi-family 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 Property

Gift funds cannot be used toward the down payment on an investment property.

What Are the Tax Implications?

Tax laws change on a fairly regular basis, so you should always speak with your financial advisor or tax professional to make sure you’re in compliance with the law.

Generally, 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.

In 2020, 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 give someone over the course of your lifetime.

The bottom line for all gift money is that 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. 

 

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