Mortgage Down Payment Gifts: The Ultimate Homebuying Hack
"May your home always be too small to hold all your friends." - Traditional Irish Blessing
Saving up for a down payment has become a Herculean task in recent years. The average home price in the United States during the first half of 2022 was over $428,000. This means that a 10% down payment is over $42,000, which is no small figure.
Soaring prices have led homebuyers to explore alternative options to fund their down payment, such as down payment gifts. In fact, over 28% of buyers used a gift for part of their down payment in 2021.
Chances are good that you have generous family members and/or friends that want to help you out with your first home purchase – 79% of parents would assist their children with a down payment according to Morning Consult.
Any and all help is welcome for aspiring first-time homebuyers, but there are some rules to follow when it comes to funding sources and mortgage down payments.
If you can use the gift money toward your down payment, excellent. If you can’t? Use the money to pay for other bills and put those savings toward your down payment. The bottom line: if you can get financial support in the form of a gift, take it!
Here’s how a down payment gift works, the tax implications, and the rules to follow:
What is a down payment gift?
A down payment gift is when someone gives you money to help with the purchase of your home. This type of gift is often used by first-time homebuyers who may not have the savings for a traditional down payment (or proceeds from the sale of a previous home).
Down payments gifts allow you to put down a larger down payment than you would otherwise be able to, which expands your homebuying budget and/or lowers your monthly mortgage payment. A gift may also free up funds that you were going to use as a down payment for renovation (or maintenance) expenses on your new home.
Do lenders care where your down payment comes from?
Yes. Lenders want to make sure you’re able to consistently pay your mortgage every month. If you’re borrowing money for your initial down payment, that puts more stress on your budget. This extra debt could make you less likely to make your payments on time.
Lenders also want to verify the down payment funds are actually in your possession. If you get all the way to closing and the promised gift funds never appear, you’ll run into trouble.
If you are thinking about using a down payment gift to buy a home, there are a few things to keep in mind:
- You will need to provide the lender with documentation of the gift, such as a letter from the donor or a bank statement.
- The donor will need to sign a gift letter, which states that the money is a gift and not a loan.
- You may need to get a separate gift letter from each donor if you are receiving multiple gifts.
- The gift cannot be made by someone who is financially involved in the transaction, such as the seller or real estate agent.
- The donor may be asked to provide proof that they have the financial ability to give you the gift.
Who is allowed to give you money for your down payment?
There are a few restrictions on who is allowed to financially help you out based on the mortgage type.
- Family: family members can provide gifts regardless of loan type – up to 100% of your down payment.
- Friends: although friends are typically restricted from helping out with conventional mortgage down payments, they can assist with FHA loans, USDA loans, and VA loans (as long as certain conditions are met).
- Employers: your employer can also contribute to FHA, VA, or USDA loan down payments.
Every lender will have its own criteria – the best thing to do is reach out and get the details on what’s allowed for the type of mortgage you’re considering.
How much gift money can you receive towards your down payment?
FHA, USDA, VA and conventional loans allow the entire down payment to be a gift.
If you plan on getting a VA loan, you can put zero money down if you wish to or you can put some money down to lower your mortgage payment if you prefer. You can also get a USDA loan with zero money down.
Conventional loans require 3-20% down payments while FHA loans have small down payment requirements, which can be as low as 3.5%.
If your gifts do not meet the required down payment for your loan, you will need to make up the difference using your own funds.
Is gift money taxed?
No, gift money is not taxed for the recipient and only in rare cases will the donor be taxed.
The donor will need to file a gift tax return if they give you more than $16,000 in a single year, but as long as they have not met their lifetime exclusion amount (currently set at $11.7 million), they will not have to pay any taxes.
The $16,000 annual gift limit is per person. If you are buying a house with a spouse, you could each receive $16,000 (so $32,000 total) from a single giver. If the gift exceeds the annual exclusion amount, the gifter will need to complete a gift tax return (Form 706).
Can I pay the person back later?
No, you cannot pay the person back later. The money needs to be a true gift with no expectation of repayment. If the donor tries to give you a loan disguised as a gift, it will not be accepted by the lender.
How do I prove the money is a gift?
The donor will need to sign a gift letter, which states that the money is a gift and not a loan. You will also need to provide documentation of the gift, such as a bank statement or letter from the donor. If you are receiving multiple gifts from different donors, each donor will need to sign a gift letter and you will need to provide documentation for each gift.
Most lenders will have a very simple template to use for gift letters that will include the following information.
- The dollar amount of the gift
- The date the funds were transferred
- The donor’s signed statement that no repayment is expected
- The donor’s name, address, and phone number
- The donor’s relationship to the borrower
- The address of the property being purchased
When should I plan to receive the gift money?
The timing of when you receive the gift money will depend on the donor. They may give you the money all at once or they may give you smaller amounts over time.
Some donors may want to wait until after you have found a home and are under contract to purchase it. This is so they can be sure that the money will be used for its intended purpose. Other donors may want to give you the money as soon as possible so you can start the homebuying process.
It is up to the donor when they give you the money, so you will need to work out a timeline that works for both of you.
In general, the earlier you receive the funds the better.
What’s the best way to collect gift money for a down payment?
The primary way to receive gift money for a mortgage is to have you or the donor deposit the money directly into your bank account via check or transfer. It may also be possible for the gift to be wired directly to your lender.
But be prepared: your lender will need to verify that the money is a true gift and not a loan, so it is important to follow their instructions on how to properly document the gift.
When do I NOT need a gift letter?
If the gift was made more than two months ago and has been deposited in your bank account (and appears on two bank statements), the lender will consider the gift “seasoned” and will generally not ask for documentation for the source of the funds. Although, they still may!
Additionally, if you received many smaller gifts, the lender may not ask for documentation of each small deposit.
Down payment assistance programs are not considered gifts, and you will not need a gift letter for any funds from those programs. Down payment assistance programs are government-sponsored programs that provide financial assistance to homebuyers.
Should I ask friends and family to contribute to my house fund?
Yes! It is far more common than you may think and the best way to turbocharge your home savings. If you have friends and family who are willing and able to help you with your down payment, it can be a great way to come up with the money you need.
Just follow the gift-receiving guidelines so you don’t run into any problems with your mortgage.
What should you watch out for?
Three final tips when you’re getting a down payment gift:
- You should not change the amount of the gift or down payment at the last second since this will require the lender to update your loan paperwork, which could delay your homebuying timeline.
- Prior to accepting the gifts, you should ensure that your lender will accept the source and amount of the gift.
- Make sure all of your gifts are properly documented because it can be hard to track down givers at the last moment.