Sellers that sell their home to a family member may give them what is called a gift of equity. This ‘gift’ can be used as the buyer’s down payment for most loan programs. This can help certain borrowers qualify for a loan that they might not otherwise have enough of a down payment to qualify.
This program only applies to family members, otherwise, it’s considered less than an arm’s length transaction, which is not allowed. Interested parties in a purchase transaction could be accused of coercing a buyer to buy the loan in any transactions that don’t’ involve a family member.
In order to be able to use the equity, the donor must provide the lender with a letter stating the relationship between the buyer and seller, the amount of the equity given, and state that there is no expectation of repayment.
The Reasons Sellers Give a Gift of Equity
It might seem strange that anyone would want to give up their equity, but for family members, it can make sense. For starters, when someone sells their home to a family member, they don’t need to use a real estate agent. That right there saves the seller 6% in fees. On a $200,000 home, that means as much as $12,000. Sellers can give this amount to the buyer (the family member), saving the hassle of finding a buyer while helping a family member at the same time.
Sometimes the reason for giving the gift of equity isn’t financial. Some people just like to keep their home in the family. It’s also a great way to help children buy a home when they would otherwise be unable to afford the down payment.
Determining the Gift of Equity
The amount of the gift of equity is dependent on the outstanding mortgage balance the seller must pay off as well as the true appraised value. The seller will have to wait until the appraisal is conducted on the home to determine the true gift of equity.
For example, if an appraiser determines the home you are selling is worth $250,000 and you have $100,000 in outstanding loans on the property, you have $150,000 in equity. You can choose to gift some or all of the equity that you have available. You control the amount of the gift by determining the sales price you want to sell the home for to your family member.
Using our above example, let’s say you decide to sell the home to your family member for $200,000. This means that you gift $50,000 in equity to your family member.
Qualifying for the Loan
As the buyer, you then have to qualify for a loan for the remainder of the funds needed to buy the home. Typically, lenders allow you to use the gift of equity as the down payment. For example, if you receive 20% of the value of the home as a gift, you don’t have to put any of your own money down. If you have the credit scores and debt ratios to qualify for conventional financing, you can do so without paying PMI.
If, however, the gift of equity only partially satisfies the down payment requirement, you’ll have to put the difference down. For example, if the home is worth $250,000 and you receive $10,000 as a gift and the required down payment is 5%, you would need to put $2,500 of your own money down.
Giving a family member the gift of equity is a great way to help them buy a home. Most loan programs allow the use of this type of equity, making it easier to qualify for a loan. Check with your lender before you assume you can use this tactic, though, to make sure it’s allowed by your actual lender.