*As of July 6, 2020, Rocket Mortgage® is no longer accepting USDA loan applications.
Has a generous relative given you down payment money for a wedding gift or graduation? It’s likely that you’re extremely grateful for the gift money, and that’s completely understandable.
Do you know how to use the gift money appropriately to purchase a home? We’ll straighten out the details, help you understand the tax burdens of using a gift of cash (as opposed to a gift of equity) for your down payment and show you how to minimize your liability.
If Someone Gives Me Money, Why Do I Need A Gift Letter?
Let’s say someone gives you money to use as a down payment. As long as you have the money, your lender shouldn’t care about the source – right?
Many homeowners assume that as long as they have a down payment that’s large enough to meet a lender’s standards, they’ll have no trouble getting a loan. Unfortunately, this isn’t always the case.
Lenders need to know that you have the means to pay back your loan. If you have a large gift you want to use for your down payment, you might run into trouble during the underwriting stage of getting your mortgage.
Underwriting is the process that lenders use to verify your income and assets before they give you a loan. It helps a lender make sure they aren’t giving a loan to someone who can’t pay it back.
When you start the underwriting process, your lender will ask you for bank account statements, tax documents and W-2s. These documents prove your income and the assets you have in your bank account.
You may need to provide more than a single month’s worth of bank statements. This is because lenders want to see what kind of money you’ve had in your account for a long time and which assets are new.
Large financial gifts create a problem if they’ve been in your account for less than 2 months. If a lender sees a sudden influx of cash, it could trigger some red flags.
The lender needs to know the money that came into your account is a gift, not a loan. Loans hinder your ability to pay back your mortgage and add an additional layer of risk for the lender.
Can’t prove the money you’re using for your down payment is a gift and not a loan? Your lender might deny you a mortgage.
The solution is to ask for a gift letter to accompany any large financial gift you use for your down payment. A gift letter is a statement that ensures your lender the money that came into your account is a gift and not a loan. The person who gave you the money must write and sign the gift letter as well as provide their personal information.
How much money do you need to receive before a gift letter is necessary? Do you only need a gift letter for deposits that are more than $10,000? What about the relative who gave you a card with $50 – do they need to provide a gift letter?
As a general rule, lenders will want you to explain any gift you receive that’s over half the value of your total household monthly income. For example, if you earn $4,000 a month from your salary, your lender will want you to explain any gifts you receive that are more than $2,000.
This standard guideline applies to conventional loans, VA loans and jumbo loans. For a USDA loan or FHA loan, your lender will want an explanation for any deposit that’s larger than 1% of the adjusted purchase price or appraised value of your home, whichever is larger.
A gift letter isn’t always the only evidence needed to prove that the money in your account is legitimate. Your lender might contact your donor and ask them to provide withdrawal and deposit slips to verify the transaction. These slips tell the lender your relative had the money in their account before they gave it to you and that they haven’t taken out a loan to fund your down payment.
You can take a few steps ahead of time to make sure your gift letter passes your lender’s standards. We’ll also show you how to write a gift letter so you can help your donor prepare for underwriting.
Gift Letter Regulations By Loan Type
The amount of money you can accept in a gift for your down payment varies depending on the type of loan you get. Let’s take a look at how your loan type can affect your gift money.
Conventional loans owned by Fannie Mae and Freddie Mac only allow you to use gift money that comes from members of your family. In the context of getting a mortgage, family members include:
- Your spouse
- Your parents (biological, adoptive, step and foster parents all qualify)
- Your grandparents or great-grandparents
- Your aunts and uncles (including step-relatives)
- Your cousins (including step-relatives and adoptive relatives)
- Your nieces and nephews (including step-relatives)
- Your in-laws (including parents, grandparents, aunts, uncles, brothers-in-law and sisters-in-law)
- Your children (biological, adoptive, step and foster children all qualify)
- Your siblings (including step-relatives, foster and adoptive siblings)
- Your domestic partner
- Your fiancé or fiancée
You may also use gift funds from a future in-law if you get your loan from Fannie Mae.
Like a conventional loan, FHA loans allow almost all of your family members (including future in-laws) to provide you with a gift for your down payment. The only difference is that normal FHA guidelines say you can’t use gift funds from cousins, nieces or nephews.
However, FHA guidelines do allow gifts from close friends who show a clear interest in your life. This can extend to family members you’re close with (such as cousins, nieces and nephews), close friends and even ex-spouses.
FHA guidelines also state that you may receive a gift fund from:
- Your employer
- Your labor union
- A charitable organization that provides financial assistance
- A government agency or public entity that provides home-buying help to first-time homebuyers
USDA And VA Loans
USDA and VA loans don’t have many restrictions on down payment gifts. Almost anyone can give you gift funds to use when you buy a home with a USDA or VA loan. The only exceptions are parties who have a vested interest in the sale, including:
- The person selling the home you’re buying
- The person or company who built the home you’re buying
- The developer of the home you’re buying
- Your real estate agent or the seller’s agent
Gift Letter Regulations By Property Type
There are no limits on the amount of gift money you can use for a down payment. However, you might need to contribute at least a certain percentage of your own money to your down payment. It depends on your property type. Let’s take a look at the differences.
You may use gift funds to buy a primary residence. In fact, you don’t need to use any of your own money to fund your down payment if you’re buying a single-family unit.
You also don’t need to use any of your own money if you’re buying a multi-family unit as long as your down payment is at least 20% of your loan value. However, you must contribute 5% of your own funds toward your down payment if you’re contributing less than 20% to your down payment.
The rules for down payments on second homes are the same as the rules for your primary residence. All of your money may come from a gift if you have a down payment of at least 20%, and at least 5% of your down payment needs to come from your own funds if you have a down payment of less than 20%.
You can’t use gift funds for the down payment on an investment property.
The Logistics Of Gift Letters: Taxes, Time And Format
Now that you’ve decided to use a gift for your down payment, how do you maximize your chances of getting a loan? Let’s look at the tax implications of receiving a gift for your down payment and how you can minimize your risk.
Gift Letter And Taxes
You usually aren’t responsible for paying any tax on the money you receive because you’re the person receiving the gift. However, the person who gave you the gift might have to. Let them know about gift tax laws so they can prepare for next tax season.
The annual gift exclusion is $15,000 for 2019, which means your donor doesn’t need to report anything if they give you less than $15,000. They’ll need to file a gift tax return if they give you more than that amount.
A gift tax return discloses to the government the amount they’ve given to you. Filing a gift tax return doesn’t mean the donor automatically has to pay anything. It just deducts the current gift from their lifetime gift tax exclusion, which dictates how much a person can give throughout his or her life.
Keep in mind that tax laws change frequently. Speak with a tax adviser to make sure you have a good understanding of the current laws.
Allot Enough Time
You can save yourself some time when you apply for a mortgage by timing your deposit correctly. Most lenders consider your assets secure when they’ve been in your account for at least 60 days.
If you have a major financial gift you want to use for a down payment, it’s a good idea to wait to apply for a mortgage until that 60-day limit passes. From there, your mortgage company is less likely to be suspicious of the money in your account.
Sample Gift Letter Format
Your lender might give you a template to follow if you tell them you’re using a gift for your down payment. If they don’t give you a template, you can use our sample template below and just enter your own information:
[Donor name, address, phone number and relationship to recipient]
[Recipient name and new property address]
[Dollar amount of the donated gift and date the gift was or will be given]
[Indicate whether the recipient will use (or has used) a portion of the gift for their earnest money deposit]
By signing this gift letter, both the donor and recipient confirm that they didn’t receive the gift funds from any person, business or entity that has any interest in the property being sold or any person connected to the transaction (such as the seller, real estate agent, builder, mortgage banker or any entity associated with them). The recipient and the donor also agree that the gift does not have to be repaid.
[Your signature] Date
[Donor signature] Date
Lenders need to know the money you use for your down payment is yours, not a loan. This can create problems if you want to use a large gift to pay for your down payment.
You’ll need to get a gift letter from the person who gives you money. A gift letter assures your lender that the sudden influx of cash in your account is a gift and not a loan.
Your lender might also ask your donor for withdrawal slips from the transaction. Your donor needs to file a gift tax return if they give you more than $15,000 in 2019.
There’s no limit to the amount of gift money you can use for a down payment. However, whether or not you must contribute some of your income depends on the type of home you’re buying.
You may also face limitations as to who can give you gift money, depending on the type of loan you get. Talk to your lender to learn more about their gifting policies.
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