How to Document Gift Funds: FHA vs. Conventional Home Loan
With many Millennials entering the housing market this year, it’s likely they might need an extra push with that huge pile of school loans they graduated with.
The most expensive part of buying a home is often the down payment, and if you want your child to move out of your basement, you might want to help them along with a gift fund.
Even if you aren’t a Millennial, we could all use a little assistance in terms of money 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.
Unlike a loan that has to be paid back, gift funds can be used toward large purchases like putting a down payment on a home, which can be a huge help if you’re struggling to come up with a sufficient payment (20%).
In order for funds to be considered a gift, there must be no expected or implied repayment of funds 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.
However, your lender could be a little more lenient here. For example, if your godparents give you the gift funds, they could make the case that they’ve been like family to you all of your life and your lender might therefore give you the green light.
So whether the gift comes from parents, grandparents, siblings, children or even your spouse, you have multiple sources to receive from.
How do I give a gift fund?
If you’re feeling generous and looking to help your relative big time 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 give is up to you, but if you want to be exempt from taxes, you’ll need to know the annual gift tax exemption rule.
For example, let’s say that you want to give a gift fund to your child that’s moving out. To be exempt from taxes, the most you can give your child in any given year is $14,000 per child. If you’re married and feeling super generous, you and your spouse can each give a child $14,000, totaling to $28,000 for that year and still won’t have to worry about taxation.
If you want to give more money in a given year, be prepared to pay gift taxes, with the maximum gift tax rate at 35%.
You’ll also need to consider gift letters.
Whether your receiver is using your gift fund for just part or all of their down payment, they’ll need you to write a letter to their mortgage company that clearly explains the money if a gift and not a loan.
So once you so kindly give the gift, you’ll want to include a letter with the following information:
- Your name, address and phone number
- Your relationship to the receiver
- The dollar amount of the gift
- The funds transfer date
- Your signature
- The address of the property the receiver is buying
This letter should only be as long as necessary and shouldn’t have any useless information.
Once your letter is written, don’t forget to leave a proper paper trail when giving the fund. 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 slightly differ when you apply for a conventional loan. Here are some things to keep in mind:
- All of your down payment funds can be a gift if you put down 20% or more.
- If you can only put down less than 20%, then only part of the money can be from a gift while the rest will come out of your own pocket.
- Gift money can only be used on primary residence 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%.
As long as 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:
- Your entire down payment can be gift funds
- 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)?
You now have your gift fund check in hand and are 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.
Now that that’s out of the way, you’ll need to deposit your check in-person – not online. This is a huge sum of money you’re dealing with, so you’ll want to avoid putting all of your trust into technology.
The bank account you deposit your check into should be the same one you will use for all of your money at closing. You can then deposit the gift fund, end your transaction and collect your receipt. If you plan on depositing more than one gift fund, do not combine your gifts. This will make it harder on your lender.
Once that’s all taken care of, you’ll take the next steps with your lender, in which you should first understand the underwriting process.
Mortgage underwriting is a process in which your lender determines the risk of giving you a loan based on your credit score, income and assets. They’ll check to ensure that the money in your account makes sense based on those factors so they know that you can afford a mortgage payment and can pay back the loan.
You obviously can’t use your gift fund if you can’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 everything else that buying a home entails.
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 mortgage insurance and pay off their home sooner. They’ll also be able to qualify for the lowest mortgage rates offered by their bank.
If you’re looking to buy a home in the near future, it might be time to patch up your relationships with your relatives and throw some hints their way. Perhaps you can request the gift fund in lieu of the expensive honeymoon your parents were going to pay for, or that new car they said they would help you buy.
Whatever the case, a gift fund can help you to move into the home you’ve been dreaming of, so don’t forget to send a huge thank you, and keep your donor in mind around the holidays.