You can receive as much as 6% of a home’s sale price as a gift. While that sounds amazing, there are certain rules you must know. If you don’t follow the rules to the letter, you could find yourself without the ability to use the funds and possibly even without a loan.
Gift Funds are Valuable
Gift funds can help you in many ways. For some, it’s the only way they can buy a home if they don’t have any of their own funds to put down on it. For others, it helps their case when a lender considers their application ‘risky.’ A higher down payment suddenly lowers the lender’s risk and increases the borrower’s chance of approval.
The good news is you can accept gift funds for almost any loan program. Conventional and government-backed programs allow gifted funds. They all have the same requirements regarding how you document this help with your down payment as well.
Get the Gift Letter
The first step is to create a gift letter. This letter must contain very limited information, but you must touch upon all of the following points:
- The amount of money the gifter is providing
- The address of the property you will purchase with the funds
- How you and the gifter are related
- A statement from the gifter stating that the money is not a loan
The letter is the first step in the process. It’s the lender’s way of proving that the funds are not a loan hidden as a gift. The giver and recipient must both sign the letter. This starts the process. You will then have to handle the money itself.
Giving the Gift
The buyer’s lender needs to see a paper trail of the funds you give to the buyer. Whether you take the funds from your already seasoned checking account or you sell an asset to provide the funds, the lender needs to know.
If you take the funds from your checking account, the lender will need to see the last few months of your bank statements. This will allow them to see if you deposited the money in this account recently. If so, be prepared to provide proof of where the funds originated. The lender will need to go as far back as they see necessary until they feel satisfied that your funds are not a loan of any sort.
If you sell an asset or even stocks to gift the funds, you’ll need a paper trail of the sale of the asset and the transfer of funds into your checking account.
Once you have the funds available, you write a check to the buyer directly. The amount must be for the amount you wrote in the gift letter and not a penny more. Make a copy of the check for yourself and for the lender as this is part of the paper trail they will need as well.
Accepting the Down Payment Funds
Now it’s time for the recipient to start a paper trail. The moment the funds are received, you should deposit them in the account you will use for all costs related to the loan. For example, if you are paying the closing costs out of your own pocket, deposit the gift funds in the account that you will use for the closing costs. This eliminates confusion down the road pertaining to the lender.
When you deposit the funds, make sure you receive a deposit receipt for this transaction only. This will be proof to the lender that you deposited the funds in the right account and for the right amount.
You will then provide the lender with all of the documents received from the giver and the recipient. Again, make sure all dollar amounts are exact to the penny and no other monies get intermingled with the transactions pertaining to the home purchase.
A Real-Life Example
Let’s look at a real-life example of how gift funds work for a down payment.
John is buying a home for $200,000. He is using conventional financing and wants to put down 10% on the home. He has 4% of the money, but needs the additional $12,000, which his parents agreed to provide.
John and his parents write up a gift letter stating the property address that John will buy, the date, the amount of money they are providing, $12,000, and the fact that it is not a loan and they do not expect repayment at any time.
Next, John’s parents sell stocks to get the $12,000. They document the sale and the transfer of the funds into their checking account. They then write the $12,000 check to John and copy it. John then takes the check to his bank and deposits it in person. He receives a receipt for the $12,000 deposit and copies it. John then provides the letter, proof of the stock sale, transfer of funds receipt, and deposit receipt to the lender.
As you can see, you must document every single step when giving or accepting gift funds. Most loan programs allow the use of the funds, but only if every step is done correctly. Even just one penny difference or one missed sentence in the letter could render the process useless. Work closely with your lender to ensure that your process goes as smoothly as possible.