Using gift funds for down payment

One of the biggest challenges facing first-time homebuyers is coming up with that coveted down payment. Those fortunate enough to have parents willing and able to help out will have a big hand up.

Tapping into the bank of mom and dad is an increasingly popular idea. In fact, a survey conducted for loanDepot by GFK Custom Research North America found that 17 percent of parents with adult children ages 18-35 expect to help them buy a home in the next 5 years, compared to 13 percent in the past five years – an increase of 31 percent.

That’s great news, but there are a few things to keep in mind when using gift funds from family and friends to buy a home.

✔ Source of funds: Many lenders put restrictions on who can give you money for a down payment. This is typically limited to immediate family, such as parents and grandparents. Some lenders might be willing to make an exception to that rule if you can prove the person gifting the funds is close to you. For example, say your godparents want to gift you down payment money. You can probably prove that they’ve been involved in your life along time and the lender may accept their funds. Most of the time, however, the lender’s hands are tied because the requirements are passed down from the federal government through Fannie Mae and Freddie Mac, the two biggest entities that buy mortgage-backed securities.

✔ Think about taxes: The IRS allows every taxpayer to gift $14,000 a year to as many people as they like tax free. That means each parent can gift his or her child and child’s spouse a total of $56,000 a year without paying taxes. Each parent should write separate $14,000 checks to each recipient to maintain proper documentation. Once that $14,000 limit is exceeded, however, the gifter, not the giftee, is subject the federal gift tax. This gift does not need to be included on the receiver’s annual tax return. There is an exception to this rule. If the gift is more than $14,000 from each parent, the parent can file the gift under the lifetime exemption rule, which allows parents to gift their children up to $5.4 million a piece tax free as an inheritance. For example, if your parents wanted to gift you and your spouse $100,000 to buy a home, we know the first $56,000 would be tax free under the annual exemption rule. But what about the other $44,000? Your parents could file form 709 under the lifetime exemption rule and that portion could be a lump sum payment.

✔ Documentation requirements: Perhaps one of the most important aspects of using gift funds to buy a home is that the lender will require the gift to write a letter state the gift is truly that and will not need to be paid back. Your lender will track this gift as painstakingly as the track the rest of your financial information. The lender will provide the letter for both you and your donor to sign. The lender will also require bank statements from the donor to ensure they actually have access the funds they’ve pledged.

Other things to know about gift funds:

✔ If you’re putting more than 20 percent down, it can all come from gift funds
✔ If you put less than 20 percent down, some lenders require that a portion of that down payment be from your own money
✔ You can not use gift funds on investment properties

VA and FHA allow your entire down payment to be gift funds unless your credit score is under 619, then 3.5 percent must be your money.

There is one way, however, to get around all these requirements – and it’s completely legal. If the donor were to give you the funds early enough so that they sat in your bank account for a minimum of two months – 60 days – the money would be considered “seasoned” funds and exempt from all these gift rules, minus the taxes, of course.

This method requires a lot of trust on behalf of the donor because once those funds are in your account, in theory, you could do what ever you like with them.

Published June 16, 2015

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