Gift letters are an important part of validating money given to you for the down payment or closing costs on a home.
Ten percent of recent homebuyers received gift funds to help with the purchase of a home, according to a 2021 National Association of Realtors® (NAR) survey. For younger homebuyers, that number jumped to 23%.
Properly documented gift funds will help the mortgage loan to pass underwriting so your loan may be approved. Homebuyers often wonder, “How much are down payments typically?” Down payments come in all shapes and sizes, with the average first-time homebuyer putting down 7%, and repeat buyers, 17%, according to another NAR report.
What Is a Gift Letter?
A mortgage gift letter is a legal document whose primary purpose is to state that down payment funds given to the borrower are not expected to be repaid. The lender wants to ensure that the borrower is not taking on more debt to help finance the mortgage, even if it is money from family or friends. The letter is required to pass underwriting.
It’s essential that a gift letter include all the necessary elements to be considered in your loan application.
What Should Be Included in Gift Letters?
Lenders usually provide a standard gift letter for you and the donor to complete, but it’s helpful to know what needs to be stated. Gift letters should include the following details:
• Dollar amount of the gift
• Name of the donor, address, phone number, and details of the account from which the money will be or was drawn
• Relationship to the borrower
• Name of the borrower, address, and phone number
• Address of the home associated with the down payment
• The donor’s signed statement saying the funds will not need to be repaid by the borrower
• Language saying the funds were not made available to the donor by any party interested in the sale of the property
• The dated signatures of borrower and donor
Note: Along with a gift letter, the lender may want to see proof of funds in the donor’s account and evidence the money was deposited into the borrower’s account.
Does Timing and Amount Matter?
When it comes to gift letters, when and how much you received may need to be documented.
Amount
There typically is no limit on the amount of gift money, but when a deposit is more than half of your monthly household income, lenders usually will want an explanation.
For USDA loans and FHA loans, you’ll need to explain any amount over 1% of the purchase price or appraised value of your home that was deposited in your account recently. There are exceptions, including tax refunds and bonuses, that do not need to be “seasoned” or explained.
Timing
A lender will look at bank statements for the past 60 to 90 days. Amounts that existed in your account before this time are considered seasoned, and you may not need to provide a gift letter for that money. The amount of a deposit inside that time frame may need a letter of explanation.
If you have money in other places, you’ll want to deposit it into your bank account for proper seasoning.
Who Can Give Down Payment Gifts?
Down payment gift regulations vary by loan type, but generally, gift funds are allowable on many mortgage types from close family members or friends. There are some key differences between regulation for down payment gifts for conventional and government home loans (FHA, USDA, and VA mortgages).
FHA Loans
Under Federal Housing Administration guidelines, gift funds for the down payment are allowable from the following donors:
• Relatives of the borrower
• The borrower’s employer or labor union
• A close friend with a clearly defined and documented interest in the borrower
• A charitable organization
• A government agency or public entity that provides homeownership assistance to low- and moderate-income families or first-time homebuyers.
The gift must not come from an entity that has an interest in the sale of the property, such as the seller, the builder, the real estate agent, or the broker.
Buying a fixer-upper? This guide to FHA 203(k) loans and options could be a good read.
Conventional Loans
Under conventional (non-government) loan guidelines, gift funds are allowable from these sources:
• A relative, which Fannie Mae defines as someone related by blood, marriage, adoption, or legal guardianship
• A domestic partner or fiance
The donor may not be anyone with an interest in the transaction, such as the builder, developer, or real estate agent.
Recommended: What Is A Conventional Home Loan?
USDA or VA Loans
With loans backed by the Department of Agriculture or Veterans Affairs, the only people who cannot provide gift funds are those who would benefit from the sale, such as the seller, lender, real estate agent, or developer. The gift funds must be properly sourced, which means the lender wants to see a paper trail from the bank account of the donor to that of the borrower.
Are There Limits on Gifts?
No, but some loans may require borrowers to come up with a portion of the down payment. This is what’s known as a minimum borrower contribution, and it applies to conventional loan financing. It is different based on what type of real estate is being purchased, be it a primary residence, second home, or investment property.
Primary Residences
For primary residences, there is no minimum borrower contribution. All of the money needed to complete the transaction can be a gift. This is true whether the loan-to-value ratio is above or below 80% for conventional financing.
Second Homes
For second homes, if the loan-to-value is above 80% (meaning the down payment was less than 20%), borrowers must make a minimum contribution of 5% from their own funds. This is also true on principal units with two to four units.
Investment Properties
Gift funds are not allowed on conventional mortgages for investment properties.
Recommended: How to Buy a House From a Family Member
How Does This Affect Taxes?
Taxes may affect the donor of the funds, unless the home purchaser makes special arrangements to pay taxes on the gift funds.
The money gifted may be excluded from tax as per the annual exclusion amount. The IRS says the annual exclusion for gifts is $16,000 for 2022. This is per person, so if buying real estate with a partner, the amount doubles to $32,000.
If the gift is from a set of parents, each parent can gift that amount to each of the borrowing partners. This allows for $64,000 to be gifted before triggering the gift tax. In other words:
• Parent 1: $16,000 for borrowing partner 1, $16,000 for borrowing partner 2 = $32,000
• Parent 2: $16,000 for borrowing partner 1, $16,000 for borrowing partner 2 = $32,000
Adding the amount for both parents contributing for both borrowers equals $64,000.
If that amount is exceeded, each donor can also claim it as part of the lifetime exclusion on estate taxes, which has a limit of $12.06 million for 2022.
Gift Equity Letters vs Gift Letters for Mortgages
A gift of equity is when the seller gives a portion of the home’s equity to the buyer. It is transferred to the buyer as a credit in the transaction and may be used to fund all or part of the down payment on principal or second homes.
If there is a gift of equity, a gift of equity letter is required. A signed gift letter and settlement statement with the equity gift will be retained in the loan file.
While there are similarities, there are also some differences.
| Gift of Equity | Gifts for Mortgages |
|---|---|
| Must be applied as a reduction in purchase price or credit | Gifts can be an unlimited amount but are not accepted for investment properties |
| Borrower may not receive cash back at closing for gift equity | Borrower can receive funds back at closing |
| Required to notify appraiser of equity gift | Appraiser doesn’t need to know about it |
| Is from the seller, who can be a relative. For FHA loans, only equity gifts from family are acceptable | Is from a donor related to the borrower |
| Can be used to fund the down payment and closing costs | Can be used to fund the down payment and closing costs |
| Permitted for principal and second homes | Permitted for principal and second homes |
Whether you’re fortunate enough to receive a gift or you’re making your own way toward homeownership, this mortgage calculator may come in handy.
The Takeaway
A gift letter ensures that the money, or equity, you receive when buying a home is validated when your mortgage loan goes through underwriting. It’s a necessary step on your way to loan approval that a good mortgage lender may be able to help you with.
Looking for a home loan? Read up, if you wish, at the SoFi mortgage loan help center.
Then look into SoFi’s fixed-rate mortgage loans with competitive rates and low down payments. Qualified first-time homebuyers may put just 3% down.
Photo credit: iStock/Pictac
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