If you’re in the market to purchase a house, your most significant upfront expense is going to be the down payment. Having a sizable down payment isn’t always easy to accomplish, especially for first-time homebuyers.
In many cases, people rely on money that was gifted to them to help make the down payment. This tends to be true for younger homebuyers who are getting financial gifts from family members or friends to help.
There are strict rules regarding the transfer of cash for a home purchase. From traditional loans to bank statement loans and everything in between, not following the rules can hurt your home-buying dream.
Why Do Banks Care from Where the Money Came?
Thanks to the housing crisis in 2008, lenders have to be more critical of whom they lend money. New regulations require that lenders verify that borrowers are able to repay their loans. This typically consists of income verification and examining debts and living expenses.
Considering how much lenders have to dig into your finances, they want to make sure you don’t have additional debts and that you’ll be able to repay the loan. A deposit of gift money might seem pretty harmless, but the bank needs to know that this influx of cash isn’t another loan.
Even if a family member gives you money under the pretense of “You can pay me back whenever you can,” the bank wants to know. Any kind of loan can impact your debt-to-income ratio, a formula used to determine your eligibility for a loan.
To help protect lenders from defaulted loans, rules were created to determine how to deal with financial gifts. These rules tell you who can give you money towards your down payment, how to document said funds, how much can be gifted, and more.
Following these rules allows you to receive a generous gift. Not adhering to these policies could mean getting denied for your loan.
Who Can Gift Money for a Down Payment?
To make sure borrowers aren’t disguising loans as generous gifts, several restrictions were created on who can make this housing donation. There are two general groups: people who are connected to the borrower like relatives or friends, and organizations that provide financial support to homeowners.
In regards to gift funds, relatives are defined as the borrower’s spouse, child, dependent, fiance, domestic partner, or anyone related by blood, marriage, adoption, or legal guardianship. The donor cannot be someone who has something to gain from the sale of the home, such as a builder, real estate agent, or the seller.
Here is the shortlist of who is considered an eligible gift-giver:
Employer or labor union
Friend with a documented interest in the borrower
Public entity or non-profit that assists homebuyers
How Much Can Be Gifted Towards a Down Payment?
Most conventional and FHA loans allow the entire down payment to be from a gift. FHA loans typically require 3.5 to 10 percent down depending on your credit score.
In some cases, like when someone is purchasing a second home, a conventional loan might require 5 percent or more. Your specific loan may have different requirements, so make sure to check with your loan officer to understand your particular needs.
If someone gives you a check for $75 as a pre-house warming gift, your lender may not need any verification that it was a gift. On the other hand, if someone gifts you $10,000, you will need to document the donation appropriately. That’s where a gift letter can come into play.
What is a Gift Letter?
When you receive a gift towards your down payment, you’ll want the donor to write a gift letter. This is basically a note that confirms that the money was a gift and that you do not need to pay it back. This gives the lender the confidence to move forward with your loan.
The gift letter should include the following:
Donor’s name, address, and phone number
Your name and the address of the property being purchased
Donor’s relationship to the client
Dollar amount of the gift
Date the funds were transferred
Statement saying that the donor does not expect repayment
Your lender may need to verify that the funds were transferred to your account, so you may need to produce copies of the withdrawal and deposit slips. Make sure the person giving you the money knows that there will most likely be required documentation along with their gift. In some cases, the lender may require the donor to provide bank statements or something to prove they didn’t take out a loan in order to give you money.
Non-profit organizations and government agencies that provide assistance for homebuyers won’t submit a gift letter. Instead, they will have official forms that outline their donation.
Timing Plays a Role
If you know that someone is going to give you money towards your down payment, have them do so sooner than later. If money has been in your account for a substantial amount of time, it’s considered “seasoned money” and may not require any form of verification.
While each lender may have a different time frame in which they no longer need to evaluate funds, three months is often a good starting point.
What if I Use a Bank Statement Loan?
Bank statement mortgage loans allow borrowers to secure a mortgage without some of the more traditional documents like a W2 or tax return. Instead, these borrowers turn in copies of their bank statements over a period of time, usually several months. These bank statements help lenders get a better idea of your cash flow. Bank statement loans are perfect for the self-employed or anyone who has inconsistent cash flow.
If you are seeking a bank statement loan and expect a gift for your down payment, you have a couple of options. The first option is to deposit the money as early as you can. If the gift is seasoned, it shouldn’t need any explaining. The other option is to follow the same steps as you would with a traditional loan, including getting a gift letter.
Gifts Make Things Easier If You Follow the Rules
Just because there are regulations about how donations can be used for a down payment doesn’t mean you shouldn’t explore them as options. If you’re in the market for a new home, a little help can go a long way. Make sure to discuss options with your lender and follow their advice to ensure you don’t have to worry about your mortgage being approved.