How to Document Gift Funds: FHA vs. Conventional Home Loan
Millennials are in the prime of their life and starting to purchase their first homes. It’s no surprise they might some extra help with the potential of student loan debt lingering.
Usually, the most expensive part of buying a home is the down payment, and if you want your child to move out of your basement, you might want to help get them started with a gift fund.
Even if you aren’t a Millennial, we could all use a little financial assistance from time to time, couldn’t we?
What is a gift fund?
Just like the name implies, a gift fund is a gift of liquid monetary value that can be used for a specific purchase.
Gift funds can be used towards a large down payment on a home. This can be a huge help if you’re struggling to come up with funds for a down payment that you’re comfortable making.
For the funds to be considered a gift, there must be no expected or implied repayment to the donor by the borrower.
Where do I receive a gift fund?
In terms of receiving gift funds, lenders require you to follow one simple rule: all gift funds for a down payment must be from family members.
Depending on your lender, there could be a little more leniency here. For example, if a godparent provides you the gift funds, the case could be made that they’ve been like family to you your whole life, and your lender will most likely approve the gift.
So, regardless of where the gift comes from, you have multiple sources that can you reach out to for assistance.
How do I give a gift fund?
If you’re feeling generous and looking to help your relative with their down payment, a gift fund can be a great way to help them ditch the apartment and buy the home of their dreams.
The amount of money you want to gift is up to you, but if you want to be exempt from taxes, you’ll need to know the annual gift tax exemption rule.
Let’s say that you want to provide a gift fund to your child that’s moving out. To be exempt from taxes, the most you can give your child in a year is $15,000 (per child). If you’re married and feeling extra generous, you and your spouse can each provide a gift, maxing out at $30,000. If you want to provide a gift over the maximum, be prepared to pay gift taxes.
Your lender will also require a gift letter. Even if your receiver is only using the gift fund for a portion of their down payment, they’ll need you to write a letter that clearly explains the money is a gift and not a loan.
You’ll want to include the following information in your letter:
- Your name, address, and phone number
- Your relationship with the receiver
- The dollar amount of the gift
- The funds’ transfer date
- The address of the property the receiver is buying
- Your signature
If necessary, don’t forget to leave a proper paper trail when gifting the funds. This means you’ll need to make a photocopy of the check (if you choose to write one) so the receiver can provide it to their lender.
What if I’m applying for a Conventional loan?
The rules are slightly different when you apply for a conventional loan. Here are some things to keep in mind:
- All your down payment funds can be a gift if you put down 20% or more.
- If the gift doesn’t cover the traditional down payment of 20%, the remainder will have to come out of pocket.
- Gift money can only be used on primary residences and second homes.
What if I’m applying for an FHA loan?
One condition of an FHA loan approval is that the borrower should provide a minimum cash investment, which is a down payment of at least 3.5%.
If the gift and giver meet certain FHA requirements, gift funds can be used as a down payment.
Here are some guidelines when using a gift fund for FHA:
- All of your down payment funds can be a gift if you put down 20% or more.
- At least 3.5% of your down payment needs to be your own money if your credit score is between 580 and 619
- Gift funds can only be used on primary residences
How do I use my gift fund(s)?
Now that you’ve received your gift funds, you’re excited to take the next steps, but what exactly are they?
Whatever you do, don’t randomly deposit your gift into a bank account. That’s a surefire way to get your loan denied.
You’ll need to deposit your check in-person. This is a huge sum of money you’re dealing with, so you’ll want to avoid putting all your trust in technology.
The bank account you deposit the gift into must be the same one you will use for all your closing costs. Once you confirm you are using the correct account, you can deposit the funds, end your transaction, and collect your receipt. If you plan on depositing more than one gift fund, do not combine them, it will delay the loan process.
Once that’s all taken care of, you’ll take the next steps with your lender, which begins with their underwriting team.
Mortgage underwriting is the process in which your lender determines the risk of giving you a loan based on your credit score, income, and assets. They’ll verify that the money in your account adds up based on the information you provide. After this, they’ll know you can afford a mortgage payment and trust you to pay back the loan.
You obviously can’t use your gift fund if you don’t get approved for a loan. Just like buying a home with your own money, you’ll need to have a good credit score, a stable job, and be prepared for the responsibility that you take on as a homeowner.
Once your lender sorts everything out, your gift fund can be applied, and you’ll be that much closer to buying a home.
With that in mind …
The main drive of gift funds is to help buyers afford a 20% down payment, which will help them save on private mortgage insurance (PMI) and pay off their home sooner. They’ll also be able to qualify for the lowest mortgage rates offered by their lender.
If you’re looking to buy a home, it might be time to patch up relationships with your relatives and throw some hints their way. Perhaps you can request the gift fund in place of the expensive honeymoon your parents were going to pay for, or that new car they said they would help you buy.
Whatever the situation, a gift fund can help you move into the home you’ve been dreaming of. Don’t forget to send a huge thank you, and keep your donor in mind around the holidays.