What are Mortgage Gift Funds?
Mortgage gift funds, often called a down payment gift, are money given to a homebuyer by an approved donor, typically a family member, to help cover the down payment, closing costs, or other expenses when buying a home.
When using gift money, you must strictly follow the rules from your mortgage lender and/or government agency insuring the loan (like FHA or VA).
Why Do Lenders Have Rules About Down Payment Gifts?
Lenders need to verify your income and the source of your funds when you apply for a mortgage. A large down payment demonstrates financial stability. However, if that money comes from somewhere other than your own savings, the lender needs confirmation that it is a genuine gift and not a loan that you will need to repay. Repayments would impact your debt-to-income ratio and your ability to afford the mortgage.
Gift Fund Rules by Loan Type
Each mortgage type, Conventional, FHA, VA, and USDA, has its own specific rules regarding gift funds and how they can be used:
Conventional:
Property Type: Can be used for a primary residence or second home. Cannot be used for investment properties.
Usage Can fund all or part of the down payment, closing costs, or financial reserves, subject to any minimum borrower contribution requirements.
Approved Donors: Can be provided by a relative or non-relative who shares a familial relationship with the borrower.
Prohibited Donors: Cannot be provided by, or have any affiliation with, the builder, the developer, the real estate agent, or any other party interested in the transaction.
Documentation: A gift letter signed by the donor is required.
FHA Loan:
Approved Donors: Can be provided by a family member, employer or labor union, a close friend with a clearly defined and documented interest in the borrower, a charitable organization, or a government agency/public entity with a program assisting low- or moderate-income families or first-time homebuyers.
Documentation: A gift letter signed and dated by both the donor and borrower is required.
VA Loan:
Usage: Use towards the down payment (if you choose to make one), funding fees, and closing costs.
Prohibited Donors: Cannot be provided by anyone with an interest in the transaction.
Documentation: A gift letter must be provided.
USDA Loan:
Usage: You can use gift money towards your closing costs, but not towards cash reserves.
Prohibited Donors: The money can come from anyone not interested in the transaction.
Documentation: A gift letter must be provided.
Writing a Mortgage Gift Letter
The most critical step in using gift funds is providing the paper trail and documentation. Before creating your letter, first check with your lender to see if they have a gift letter template to use. A standard gift letter typically needs to include:
- The exact gift amount
- The date the money was transferred
- The property address you are purchasing
- Your relationship with the donor
- The donor’s name, address, and phone number
- A clear statement that the money is an irrevocable gift and there is no expectation of repayment (this is the most important part).
- Both the donor and the borrower must sign (sometimes the letter only requires the donor’s signature, check with your lender).
- To verify the transfer, include copies of the donor’s bank statements showing the withdrawal and the buyer’s bank statements showing the deposit.
Do Gift Funds Affect Taxes? (IRS Rules)
While your lender is concerned with the origin of the funds, many donors worry about the IRS Gift Tax.
For the Buyer (Recipient): The great news is that the gift is never considered taxable income for you. You do not pay tax on the gift.
For the Donor (Gifter): The IRS sets an annual gift tax exclusion amount ($18,000 for 2024). A donor can give this amount to any number of people each year without reporting it. However, if a gift exceeds this annual exclusion, the donor must file a Gift Tax Return (Form 709). Filing the form does not usually mean the donor has to pay taxes; it simply tracks the amount against the donor’s lifetime gift and estate tax exemption (a very high dollar amount).
Please consult your tax advisor.
Gift funds are a fantastic way to cover a down payment and other mortgage expenses, but you must be prepared to follow the rules and provide a clear paper trail to verify the money is, in fact, a gift.
If you have questions about using mortgage gift funds or are looking to get pre-approved, contact our team today!
