Receiving gift money for down payments can offer buyers much relief from an otherwise huge financial commitment. If you’re a first-time homebuyer, receiving this type of assistance can be especially useful, considering there are many other costs you’ll need to cover.
However, lenders will treat gift money differently, depending on the amount, the relationship between you and the donor, and where the money came from. Before you use gifted money for a down payment, it’s important to understand the rules governing gift money.
How gift money for mortgage down payments work
When it comes to getting approved for a loan, applicants will need to go through underwriting. This process is one where your lender assesses your assets, credit score, and income to figure out whether it would be too risky to grant you a mortgage. For the first-time homebuyer, it can seem like a long and tedious process.
When it comes to your assets, lenders want to ensure that any money in your accounts is actually yours. That means any large deposits (including gift funds for your down payment) may be subject to scrutiny. Lenders may want to confirm claims of gifted money for a down payment are indeed gifts and not loans.
The point of confirming funds is to ensure you have ample money to afford your mortgage payments and that you’ll most likely make your loan payments. If you borrowed money for your down payment, lenders may see this as potentially stretching yourself too thin financially, especially if you need to start paying that loan back in addition to your mortgage.
Depending on the type of mortgage you take out, lenders will generally require the following if you’re using gifted money for your down payment:
- Money must be a personal gift with no expectation of paying it back.
- Acceptable sources of gift funds include relatives, spouses, domestic partners, employers or labor unions, charitable organizations, or qualifying government agencies.
- Donor may not have any vested interest in the property, such as the builder or real estate agent.
- Money needs to be from the donor’s own funds.
The borrower will need to provide evidence in order to prove to underwriters that the gift money isn’t a loan. To ensure a smooth loan process, it’s important to have the required documentation ready to submit to underwriters.
Aside from providing a gift letter (more on this below), you’ll also need to verify the transfer of the gift funds or show that the funds are currently available in the donor’s account. Acceptable documentation includes a copy of the donor’s withdrawal slip, a copy of a certified check of the amount gifted, or a bank statement showing receipt of the funds.
What is the down payment gift letter and what should it contain?
A down payment gift letter is a written statement from the donor indicating the money given is a gift and doesn’t need to be repaid. Many mortgage lenders can assist you with what needs to be included in a gift letter during the mortgage underwriting process to ensure you provide proof the gift money is actually yours to keep. Whether you’re taking out a conventional or a government-backed mortgage such as an FHA loan, the donor needs to include the following information in their letter:
- Their name and contact details
- The donor’s relationship to you
- The exact amount of gift money given
- The date when money was transferred to you
- A statement indicating the money given doesn’t need to be repaid because it’s a gift
- The donor’s signature
As indicated above, the lender may require additional information regarding the transfer of gift funds. For instance, if the donor borrowed money to gift to you, they’ll need to provide evidence the borrowed money is from an “acceptable” source.
Considering a gift letter is a formal document, submitting it to a lender means it becomes a legally binding document. Since the donor is signing it with the intent of stating that the money is given as a gift, if the money is meant to be paid back, then the borrower is lying. This may be considered a form of mortgage fraud, and you and the donor could get in trouble — one of the risks of signing a gift letter.
Who can gift money for a mortgage down payment?
Permitted donors of gift funds differ depending on the type of mortgage you take out. In all loan types, donors can’t be parties or entities with an interest in the transaction or have any affiliation with the builder, real estate agent, or developer. So, if they don’t have an interest in the transaction, likely your parent could give you money to buy a house.
Here’s a look at who can gift money for a down payment for common home loans:
Mortgage down payment gift rules: Limits and restrictions
For all types of loans, there aren’t any restrictions as to the limit on gift amounts. Meaning, the donor can gift you the entire down payment amount, as long as it meets the lender’s minimum requirements.
Conventional loans don’t allow gift funds for investment properties. Though not explicitly stated, FHA, USDA, and VA loans don’t allow it either based on the fact that eligible properties have to be the borrower’s primary residence.
Here’s a closer look at gift funds rules for different types of loans:
Conventional loans gift funds guidelines:
- Homes intended as the borrower’s primary residence are allowed to use gift money to cover the entire down payment amount.
- Second homes are allowed to use gifted money as the entire down payment, as long as the gift is at least 20% of the purchase price.
- Second homes with cash gifts less than 20% or homes will require the borrower to contribute at least 5% from their own funds.
FHA loans gift funds guidelines:
- Gift money needs to come from the donor directly and from a source considered acceptable by FHA, such as from qualifying first-time homebuyer programs.
- Borrowers need to meet the 3.5% minimum down payment requirement, but all funds can come from donor.
USDA and VA loans gift funds guidelines:
- No minimum down payment requirement.
- Gift funds may not be used as reserves to meet VA loans’ six-month mortgage payment reserve requirements.
What are the tax rules for down payment gifts?
Since tax laws may change, it’s a smart idea to speak with a tax professional or your financial advisor to ensure you’re following the latest rules and regulations.
Typically, the borrower won’t be required to pay any taxes on gift funds. In other words, gift funds don’t necessarily count as your taxable income. However, the donor might have to pay taxes — even if not, it’s a good idea to be aware of IRS regulations. You can pay the taxes for the donor instead, but it can be a complex situation, and it’s best to seek the help of a tax professional.
For a donor to be required to pay gift taxes, the amount given needs to be over the annual exclusion stipulated by the IRS. The annual exclusion for 2018 and beyond is $15,000 per person who was gifted money, and in 2022, this amount jumps to $16,000. For instance, if a donor gave you $12,000 and your brother $13,000 in 2020, both amounts fall under the annual exclusion amount.
If the amount given exceeds the IRS’ exclusion amount, then the donor needs to file a gift tax return and disclose the exact amount given. It still may not mean that the donor has to pay taxes. Rather, it will go towards the donor’s lifetime gift tax exclusion, which is currently at $11.7 million.
Again, it’s best to seek the help of a tax professional to see what the tax implications are before your donor gifts a down payment for your new mortgage.
Contact a Finance of America Mortgage Advisor today who can help you prepare for the mortgage process.