Coming up with a sizeable down payment these days can be pretty tough, especially when you consider the soaring home prices that buyers have been facing lately. Conventional mortgages require at least 5% down, but a minimum of 20% is needed in order to avoid having to pay the extra costs associated with private mortgage insurance (PMI).
Saving up for a down payment is an absolute must, but you might still find yourself coming up short despite your best efforts. This is especially true for first-time homebuyers who don’t have equity in a previous home to put towards a new home purchase.
If you’ve got family members who are willing to help you out financially to pad your down payment, you’re lucky. But even then, you may be dealing with a whole new set of potential complications if the situation is not handled properly.
Before you graciously accept any monies that are extended to you for your down payment, there are a few things that you need to know first.
Down Payment Gift Donors Can’t Have Any Stake in the Transaction
Lenders usually won’t permit any down payment gifts from just anyone. An individual who might benefit from the transaction will not be allowed to contribute to the gift, such as a mortgage broker, sales agent, or seller. Down payment gifts typically need to come from a family member, including a parent, sibling, or grandparent.
In some cases, lenders may also allow cash gifts from a spouse, partner, or fiancé(e). There may even be times when the lender may consider allowing a cash gift for a down payment from a non-relative, but usually only for FHA loans, and only if the case is a strong and convincing one.
There Are Rules About How Much Can Be Gifted
If you’re putting down at least a 20% down payment towards your home purchase with a conventional home loan, all of the down payment can be in the form of a gift. If you’re putting down less 20%, a portion of that amount can be a gift, but the rest will have to come from your own funds. How this amount is divided between you and the gift giver will depend on the exact type of mortgage you are applying for.
If you’re taking out a mortgage that’s backed by the government – such as an FHA or VA home loan – the whole down payment can be a gift if your credit score is healthy. If it’s below 620, you will have to come up with a minimum of 3.5% down from your own personal funds.
For FHA- and VA-backed home loans, you can only use gift money to put towards primary residences and second home purchases, whereas gift money for conventional loans can only be used towards the purchase of a primary residence.
There Must Be a Proper Paper Trail
Detailed documentation must accompany the cash gift being put towards your down payment. For starters, a letter must be submitted, which includes the following details:
- Borrower’s full name
- Gift donor’s full name and contact information
- Gift donor’s relationship to the borrower
- Amount of the cash gift
- Subject property address
- A note stating that the cash given is a gift and there is no expectation for it to be paid back at any time
- A note stating that the donor has no interest in the property’s sale
- Signatures of the borrower and gift donor
Other documentation will also likely be required by the lender, including a paper trail that documents the transfer of funds into an escrow account, or from the donor’s bank account into yours. Both you and the gift donor will have to submit recent bank statements.
Any documentation showing how the funds were transferred will also need to be submitted. At no time should the transfer take place without proper documentation. If the gift donor had taken the gift money from another account – be it a savings account, investment, or even from the sale of a stock – there needs to be a paper trail showing where the money came from.
After the gift money is deposited into your account, you should get a receipt for the deposit to complete the paper trail.
The Gift Donor May Have to Pay Taxes on the Gift
Cash gifts for down payments will be taxed, and the person who gifts you the down payment will be liable for paying these taxes. For this reason, it’s important that the gift giver is fully aware of this fact and understands the tax implications that will be imposed.
Gift donors can give as much as $14,000 to anyone without incurring the gift tax from the IRS. If the person giving you this cash gift is married and files a joint tax return, the couple can jointly gift as much as $28,000 to a family member. Based on the same principle, a married couple can offer a cash gift to a married couple for a total of $56,000.
There are times when an agreement is made to have the borrower pay the taxes on the gift. Everyone’s tax situation is a unique one. Before you graciously accept a cash gift to be put rewards your down payment, make sure you discuss your scenario with a tax professional.
The Bottom Line
If you are fortunate enough to be getting a cash gift for your down payment, don’t forget to document it in detail for your lender. In addition, be sure that all parties understand the tax implications of such a gift and that the money is not intended to be repaid at any time. Speak with your mortgage specialist or real estate agent to have any questions you may have answered before you accept any down payment gift.