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Worried you won’t have enough cash saved to make a sufficient down payment on a home purchase and thereby qualify for a mortgage loan? Fortunately, you may be allowed to receive gift funds from qualified benefactors that can be used for your down payment. But several rules and restrictions apply.
This article will help explain how gift funds work, who can give and receive gift funds, lender rules and limits applicable, and how to write a required gift fund letter.
Gift funds defined
Gift funds are monetary funds that are bestowed to a borrower and must be used for a down payment on a home purchase that will be financed. These funds are usually provided by a family member or someone close. The good news is that gift funds are not a loan: They do not need to be repaid.
Consider that many loan programs require that you make a minimum down payment. Conventional loans backed by Fannie Mae and Freddie Mac, for example, require at least 3% down, while you must have at least a 3.5% down payment for FHA loans (USDA loans and VA loans can be had for zero down if you qualify).
Receiving a gift fund can put you in a more favorable position to be eligible for and afford a mortgage loan.
Using gift funds is more common than you think. According to the National Association of Realtors, 22% of first-time home buyers used a gift or loan from family or friends for their down payment in 2022 versus 47% who came up with the down payment from their savings and 38% of repeat buyers who used the proceeds from their primary residence sale for a down payment on their next home.
The rules regarding gift funds
While every lender can have different rules that apply to gift funds, most lenders allow gift funds to come from anyone related to you by blood, marriage, adoption, or legal guardianship.
“That usually means parents, grandparents, siblings, stepparents, legal guardians, or in-laws. Or, funds from a fiancé or domestic partner may be allowed,” explains Adam Spigelman, vice president of Planet Home Lending in Cherry Hill, New Jersey.
Some lenders allow friends as gift fund sources, but not all. Additionally, gift funds can come from organizations, non-profits, and government agencies that offer down payment assistance.
But the money cannot come from a real estate agent, seller, or any other interested party.
“The other rule that’s important to know is that the gift has to be a true gift without strings attached. You and the donor will have to sign a gift letter saying you won’t have to repay the funds, and you’ll have to provide that letter to the lender,” Spigelman adds.
Other stipulations apply. For instance, gift funds can be used for the down payment, closing costs, or other expenses related to the home purchase but not for any reserves after closing. Additionally, the amount you are allowed to receive as gift funds can range widely, from 3% to 100% of the total down payment amount, based on the loan program.
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Gift fund rules by mortgage and property type
Here are the different restrictions that apply to gift funds based on the most common loan types:
- Conventional loans. “Fannie Mae and Freddie Mac will allow gift funds to cover the entire down payment amount so long as the borrower contributes a minimum amount of their own funds,” says Malcolm-Wiley Floyd, CEO of Stairs Financial, a platform that helps low-income first-time buyers find down payment assistance. “The funds must come from a relative or other eligible source, and the donor must provide documentation of the source of funds and proof of transfer.”
- FHA loans. Here, gift funds can also be used for 100% of the down payment and closing costs, but the donor must be a relative or close friend and have a documented relationship with the borrower. Also, the donor must furnish documentation of the source of funds, proof of transfer, and a gift letter signed by both the donor and borrower. The donor must also provide a bank statement showing that the funds have been in their account for at least 30 days, too.
- VA loans. If you qualify for a VA loan because you are a veteran, active duty military member, or surviving spouse, gift funds can also be used for your entire down payment, with no restrictions on the source of the funds. “However, no one involved in the loan transaction, including the lender, can be the source of funds. Also, a seller is allowed to contribute to the closing costs,” adds Floyd.
- USDA loans. If you qualify for a USDA loan in an approved rural location, gift funds can be used for the complete down payment. But as with FHA loans, restrictions apply on the source of funds: The donor must be a close friend or relative.
Limitations may also be in place regarding the type of property you want to purchase.
“Gift funds are allowed to be used for the down payment on your primary residence, regardless of the mortgage type,” Floyd continues. “With a second or vacation home, gift funds may be permitted for the purchase, but specific rules will depend on the mortgage program and lender. For example, gift funds may be limited to a certain percentage of the second home’s down payment.”
If you are seeking to acquire an investment property, on the other hand, gift funds are usually not allowed.
Good candidates for requesting gift funds
Worthy prospects for requesting and receiving gift funds include first-time buyers who find it difficult to save for a down payment, those with low incomes who need extra cash to qualify for a home loan, individuals with poor credit, and self-employed borrowers who may require a financial boost to be eligible for financing.
“Most of the time, those requesting gift funds are first-time purchasers who have strong credit profiles but limited savings for their down payment and closing costs. These funds can bridge the affordability gap and enable buyers to enter the housing market sooner,” explains Josh Steppling, a real estate broker associate with Treasure Coast MLS Search in Stuart, Florida.
The gift funds process
Here are the steps involved with receiving and using gift funds:
- Gather the funds. The money is usually collected by your closing agent, title company, or attorney before or during closing. The donor will commonly deposit the funds into your bank account. “It’s crucial to receive the gift funds well in advance of the closing date to allow for proper documentation and processing. Some lenders may require that gift funds be in the borrower’s account for a certain period before they can be used,” says Floyd.
- Craft a gift letter with your gift giver. The transfer of funds must usually be documented via a gift letter (more on this next), which outlines the amount of the gift, the relationship between the donor and the buyer, and the source of the funds.
- Sign and send the letter. This letter must be officially signed by the donor and recipient and then submitted to and approved by the lender. Check that the lender has received your gift fund letter.
- Apply the funds. At closing, the funds are ultimately disbursed according to the loan agreement.
Understanding gift letters
The gift letter, usually required by your lender and loan program, serves an important purpose.
“The letter represents official documentation that details the amount of the gift, the donor’s relationship to the giver, and the purpose of the gift,” says Ben Gold, founder of Recommended Home Buyers. “I’ve seen firsthand the value of well-drafted gift letters in facilitating seamless transactions.”
Again, the main function of a gift letter is to ensure in writing that the funds used for the down payment are not a loan. It’s a reassurance to the lender that you and your debt are not beholden to anyone else for repayment.
A gift letter template
Your gift letter should include the following:
- Your name, address, address of the property to be purchased, and phone number
- The monetary amount given and received
- Explanation of the donor’s relationship to you, the gift recipient
- Explanation of what the gift funds will be used for
- Donor’s statement that the funds do not need to be repaid
- Date when the funds were deposited or transferred
- Name of the bank or financial institution where the funds were deposited/transferred
- Signatures of the recipient and donor
Andrew Lokenauth, a personal finance expert and founder of TheFinanceNewsletter.com, suggests using the following as a template for your gift letter:
To whom it may concern:
I [name of giver] am writing to confirm that I am gifting [amount] to [name of recipient] to be used as a down payment on a home purchase. This gift is not a loan and does not have to be repaid.
I have known [name of recipient] for [number] years and we are [relationship]. I am gifting this money because I want to help [name of recipient] achieve the dream of homeownership.
I have gifted these funds on [date] and transferred them from [bank name] to the [bank name] account of [recipient name] so that a property located at [address] can be purchased.
Name of donor
Address of donor
Phone number of donor
Email address of donor
Signature of donor
Name of gift recipient
Address of gift recipient
Phone number of gift recipient
Email address of gift recipient
Signature of gift recipient
The bottom line
Don’t be afraid to ask for financial help in the form of gift funds from a family member, friend, or loved one or to pursue down payment assistance provided by an approved organization.
“Gift funds can be a helpful source of money for the down payment, but it’s important to plan and budget for other costs associated with the home purchase – including closing costs, inspections, and moving expenses, too,” Floyd continues.