When purchasing a home, the borrower typically needs to have adequate liquid funds to cover the required down payment, closing costs and reserves. Fortunately, a borrower’s lack of funds does not preclude him or her from moving forward with the purchase. There are several allowed alternative sources of funds:
- Gift funds from allowed individuals;
- Gift of equity from allowed individuals;
- Community/agency gifts or grants;
- Community/agency matching funds subject to recapture; and
- Employer Assisted Homeownership Benefit.
Here we’ll focus on gift funds from allowed individuals.
There are restrictions on the source and the use of these gifted funds. Unless noted, the sources, documentation and restrictions apply to conventional (Fannie Mae and Freddie Mac) and government (FHA, VA and USDA) underwriting guidelines.
The allowed relationships of borrower and donor providing the gift funds are:
- Immediate family – spouse, child or dependent;
- Individual related by blood, marriage or adoption, e.g., parents, siblings, in-laws;
- Legal guardian of the borrower;
- Person for whom the borrower is the legal guardian;
- Fiancé, fiancée;
- Domestic partner; or
- A close friend with a clearly defined and documentable long-term relationship with the borrower (this is true for government loans only).
Gifts may be received from multiple donors.
There are borrower and donor documentation requirements associated with gifts:
- The donor must sign a gift letter stating the amount, source, date of transfer, and relationship to the recipient and stating that it is a bona fide gift with no expectation of repayment.
- If the gift is given prior to closing, borrower must provide documentation that the gift funds have been transferred from the donors’ account(s) and are available in the borrower’s liquid asset account(s).
- If the gift is given at the time of settlement, the donor must provide the funds to the closing agent in the form of a certified, cashier’s, or other official check or via wire transfer.
- Monetary gifts must have a documentable source; cash on hand is not acceptable.
- If the donor is using borrowed funds for the gift, the funds must be borrowed from an acceptable source. A party to the transaction is not an acceptable source.
There are several restrictions on the use of gift funds:
- A related donor may not have an interest in the sale of the property. That is, the donor may not be the builder, seller, loan officer, or real estate agent or broker associated with the transaction. There are two exceptions:
- If the borrower is the licensed selling (and possibly listing) real estate agent for the transaction, his/her commission from the sale of the subject property may be considered an acceptable source of funds.
- If borrower’s family member is the licensed listing or selling real estate for the transaction, his/her commission, or part thereof, may be provided as a gift to the borrower, in compliance with standard gift requirements.
- Gift funds may not be used for the purchase of investment properties.
- For a one-unit primary residence, gift funds may be the only source of down payment funds, i.e., the borrower does not need to contribute any funds toward the down payment.
- For a two-to-four-unit primary residence, gift funds may be the only source of down payment funds – Fannie Mae and government only.
- For a two-to-four-unit primary residence, Freddie Mac allows gift funds to be the only source of down payment funds as long as the down payment is at least 20% of the purchase price. If the down payment is less than 20%, Freddie Mac requires that the borrower must provide at least 5% of the purchase price from his/her own funds.
- For a second home, gift funds may be the only source of down payment funds as long as the down payment is at least 20% of the purchase price. If the down payment is less than 20%, the borrower must provide at least 5% of the purchase price from his/her own funds.
- Gift funds may always be used for third-party closing costs, prepaid interest, and initial funding of an escrow account.
Eligible gift funds provide a method by which a potential home buyer may move forward without personally having the required funds to close. However, it does require the generosity of a family member or other person with an allowed relationship. It is frequently used by parents to assist a child in the purchase of his or her first home.