With the high price of residential real estate, coming up with a down payment is a major obstacle for many buyers, particularly first-time homebuyers. Mortgage regulations allow people to buy homes with gift funds from acceptable donors. This enables buyers to meet down payment requirements, and can often constitute 100% of that down payment.
How does the gift process work when it comes to buying a home?
Suspend Your Own Thinking of How a Gift Should Work
In the normal course of life, people get and give gifts all the time. Whether those gifts are in monetary form or items of value, it’s a pretty simple process. You give a person a gift, the person accepts the gift, and then you both go about the rest of your lives.
Since a mortgage is a complex financial transaction, the use of gifts the purchase of homes is at least somewhat complicated. In addition to explaining the rules connected with gifts, I’ll also try to cover the reasons why such documentation is necessary.
Basic Gifting Rules for Conventional Mortgages
Regardless of the size of the mortgage, a buyer may use a gift to cover 100% of the down payment, closing costs, and even cash reserves as long as the property being purchased is a single family home, and will be occupied by the borrower as a primary residence.
However, if the property being purchased is either a 2-4 unit primary residence, or a second home, the borrowers must make a minimum contribution of at least 5% of the purchase price of the property. A gift can then be used to cover the balance of the down payment, as well as closing costs and required cash reserves.
(Note: “Cash reserves” are an amount of liquid savings buyers are required to have available after the closing on the mortgage. In most cases, it is equal to two months of payments on the property being purchased. It is considered to be a cushion that will help to prevent an early term default on the loan, and therefore it is frequently a requirement of the mortgage.)
No “Sleeping Seconds”
One of the factors that mortgage lenders look for in gifts are the potential for second mortgages. This is where a gift might be converted into a second mortgage, or even an unsecured loan, immediately after the closing on the mortgage. This is where the term “sleeping seconds” comes from. The gift is really a second mortgage or other note, but this is not disclosed at the time of loan application.
It’s not that mortgage lenders prohibit second mortgages – in fact, they do them all the time. But more to the point is that a second mortgage can only be part of the transaction if it is disclosed in the loan application, and underwritten as such at the time of approval.
For this reason, mortgage loans require a significant amount of documentation, perhaps even more than seems reasonable to an ordinary person. Be sure that in addition to providing all required documentation, that your gift will not be converted into a loan after the closing.
Who Can Be a Donor for a Gift
Not just anyone can give you a gift for the purchase of a home. As a general rule, the donor must be somebody with whom you have a close relationship. That could include a relative, such as your spouse, one of your children or some other dependent. It can also include anyone who is related to the borrower by blood, marriage, adoption, or legal guardianship.
That actually makes the field pretty large. It can include parents, grandparents, aunts, uncles, in-laws, and cousins. It can also include a fiancé or domestic partner.
However, there are also certain parties who are prohibited from providing a gift. These would include any party who stands to gain from the purchase transaction. That includes a builder, developer, real estate agent, or anyone else who is connected with your transaction to purchase a home.
Required Gift Letter
A gift letter from the donor to the home buyer is required. Mortgage lenders use standard form gift letters since they provide an opportunity for the donor to supply all of the required information. For this reason, you should request one of those standard form gift letters, rather than making up one of your own, or ask the donor to write one up.
The gift letter must contain the following information:
- It must specify the dollar amount of the gift
- It must specify the date that the funds were transferred, or will be transferred
- It must include a statement from the donor confirming that no repayment of the gift is required or expected (this is part of the “no sleeping seconds” requirement)
- It must state the donor’s name, address, telephone number, and relationship to the buyer
In the event that the donor of the gift is someone who you live with, such as a relative or a domestic partner, and where the funds will be pooled with yours to make up the required minimum down payment, the gift letter must also include a certification from the donor stating that he or she has lived with you for the past 12 months, and will continue to do so in the new residence.
The lender may also require that both buyer and donor provide evidence of shared residency. They may require such documents as drivers licenses, utility bills, or bank statements that confirm the shared residency.
Both the Source of the Gift and the Final Transfer Must be Verified
The mortgage lender will also want to verify that the donor can make the gift, as well as document the actual transfer of the funds into the buyer’s account.
Documentation can include one or more of the following:
- Copy of the donor’s check and the borrower’s deposit slip
- Copy of the donor’s withdrawal slips and the borrower’s deposit slip
- Copy of the donor’s checks to the closing agent
- A settlement statement showing receipt of the donor’s check
If the gift funds are not transferred before closing, the lender will also document that the donor transferred the funds to the closing agent. This can be accomplished with a copy of a certified check, a cashier’s check, or other official check.
Both the requirements and the documentation for gifts are somewhat complex. But lenders must be certain that the funds are coming from an acceptable donor, as well as that they are in fact a gift and not a loan or other prohibited source. Give the lender the exact documentation they require, and the whole gift aspect of your loan application will go very smoothly.