5 Guidelines for Homebuyers Using Gift Money for Down Payments
Purchasing a home is both an exciting and somewhat overwhelming experience, especially for first-time buyers. It is not surprising that for most of us, buying a home is likely the largest purchase of our lives. Most buyers save for years before purchasing homes, applying sizable down payments to reduce their monthly mortgage costs. Across the country, the median home value is $179,200. However, in areas where the cost of living is cheaper those numbers can look a lot different. For example, according to Zillow the median home value in Warner Robins GA is much less at $92,900. But did you know you might be able to afford the home with help from family? Below are 5 guidelines for homebuyers using gift money for down payments that should be helpful.
Some buyers fall in love with properties before they can fully afford their down payments. One alternative to steep monthly mortgages is to apply gift money toward home purchases. Borrowers with close family or friends who are willing to donate funds toward home purchases are fortunate. As long as buyers and donors follow the gift money guidelines and their lenders’ rules, gift money can close the financial gap for homebuyers. Here are 5 Guidelines for Homebuyers Using Gift Money for Down Payments
Gift Money Must Come From Family
First, buyers should check with their lenders to establish the rules he or she follows when providing home loans. In general, lenders apply gift money from either parents or grandparents of borrowers. Occasionally, extended relatives or close family friends are acceptable donors, but lenders are far less likely to approve their gifts.
It’s a lender’s primary job to ensure their borrowers are capable of repaying loans without default, and donations from distant or non-relatives seem suspicious, like secret loans. If such “donations” are in fact loans, borrowers have the added burden of paying back their mortgage lenders and their “gift money” donors simultaneously.
During loan pre-approval, lenders look for income history, job stability, healthy credit scores and low debt-to-income ratios before offering loans to borrowers. If any of these elements are weak, lenders may not approve borrowers and in turn reject the gift money too. Non-relative gift money is typically more acceptable on loans that lenders plan to keep rather than sell to Fannie Mae, Freddie Mac or other investors after closing. Further, gift money is not applicable toward investment properties.
Total Gift Amount Is Limited
Depending on loan type, down payments typically range from zero down to 20 percent of the total home purchase price. Borrowers offering less than 20 percent are subject to additional mortgage costs designed to protect lenders’ lofty investments, which increase borrowers’ monthly payments. These burdens add extra strain on loan repayment. Therefore, borrowers offering at least 20 percent of a home’s purchase price in the down payment can apply gift money to cover the entire amount but may incur additional costs if the loan value is over $417K..
Alternatively, borrowers offering a down payment of less than 20 percent of the home purchase price are required to pay at least a portion of the down payment themselves. For instance, if a borrower offers 10 percent down, he or she can apply gift money to cover some of the down payment, but not the entire 10 percent. Conventional loans require borrowers to pay at least 5 percent of the total down payment themselves, unless gift money covers all 20 percent.
Lenders Require a Formal Gift Letter
Part of the gift money process is for the donor to declare the money as a gift, not a loan, and document it for the lender. If borrowers plan to use gift money, they must request a gift letter from their lenders. Each lender has a form letter for both the gift money donor and receiver to complete.
The letter includes the names of the home buyer and gift money donor, and their relationship to each other. Additionally, the letter indicates the total gift amount, the date the money will be transferred, the address of the property being purchased and a legally binding statement that the money is a gift, requiring no repayment. Both parties must sign and date the formal gift letter and deliver it to the lender.
Borrowers Must Produce a Paper Trail of Gift Money
In addition to the letter, lenders require documentation proving the money transaction is legitimately from the source claimed in the letter. Cash transactions can appear suspicious to lenders and are challenging to record. Another part of this process is for the lender to verify the donor’s ability to gift the lump sum. To avoid the headache of tracking down documentation, donors and borrowers should follow one of these clear transaction procedures.
Donors can send the money directly to the buyer during the loan preapproval process. Writing a check or wiring the funds is ideal. The lender will need a statement from the donor’s account before the money transfer, documentation of the transfer and a statement from the buyer’s account after transfer.
A less document-heavy approach is for the donor to send the money directly to the escrow account just before closing. In this case, check or wire transfers are preferred. The escrow account manager then works with the buyer on the timing of the donor’s money transfer. This method requires notation in the original gift letter to state the donor will write a check/wire money to escrow for the given amount at closing.
Donors Pay Gift Tax
Gift tax implications are imposed on the gift donors, rather than gift money receivers. However, if handled properly, donors can avoid tax liability.
In 2015, the annual gift tax exclusion laws limit an individual to gift no more than $14,000 to another individual tax free. Therefore a set of parents could offer their child and his or her married partner up to $56,000 of tax free gift money in a single year. To do so, mom and dad would each write $14,000 checks to their child and in-law. Combined, all four checks equate $56,000.
Lifetime gift tax exclusion laws limit an individual to gift no more than $5.43 million to another individual during his or her lifetime without paying taxes on the transaction. Donors must complete IRS Form 709 to keep records of the total lifetime funds. These exclusion limits are subject to change annually.
Buying a home requires methodical record gathering and mortgage paperwork, especially when buyers are acquiring loans and applying gift money. Borrowers should work with their lenders to review their loan guidelines, establish acceptable terms, and determine how much they can comfortably afford to borrow.
Thank you to Tali Wee at Zillow.com for graciously sharing her expertise on this article!
Additional Gift Money Resources
How Gift Taxes are Calculated by Julie Garber on about.com
20 Facts About Buying a Home via Lynn Pineda
Down Payment Gift Money from Tim Lucas
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