Down payments create a special set of challenges for first-time homebuyers, who don’t have the proceeds from the sale of another property to offset their down payment or closing costs. It’s no wonder that first-time homebuyers can often only swing smaller down payments. According to the National Association of Realtors, while repeat homebuyers finance 84% of their purchase, just shy of the coveted 80–20 principal-to-downpayment figure, first-time homebuyers must finance 96% of their purchase on average.
You’re not alone if you find yourself short on funds for a down payment, or have difficulty getting approved for a conventional loan with the size of down payment that you can afford. But that doesn’t mean you’re out of luck, either. In addition to low down payment loans like those from the FHA, it’s possible to get money for your down payment in the form of a gift or grant from family members, friends, or employers, as well as organizations whose mission it is to help buyers achieve their dreams of homeownership. In fact, a third of millennials receive gift money and other down payment assistance to purchase their first homes. So how does it work? Read on to find out more!
The Ins and Outs of Gift Money
Over the past decade, the rising cost of living has made funding a home purchase difficult for almost everyone, but especially millennials, many of whom are approaching, or are already at, the age for buying their first homes. As the National Association of Realtors points out, while wages have increased 16% between 2012 and 2018, home prices have gone up 47%. In response, buyers in this age bracket, struggling to save enough for home purchase, are increasingly turning to alternative sources of funding, including gift money.
Having sufficient down payment funds is pivotal for securing a home loan, and the closer you get to 20% of the purchase price, the better: reaching the 20% threshold means you won’t need to pay additional private mortgage insurance premiums each month. Gift funds are one way first-time buyers can meet this number, which saves them even more down the line.
Even though receiving gift money to help with a home purchase is a common practice, many homebuyers may not know that it is even an option—and one that requires a little know-how to navigate successfully. There are a few regulations that are pretty easy to follow, but if you don’t know what you’re doing you might encounter a hiccup in your home loan application process that could cause delays in closing or the denial of a loan altogether. Below you’ll find information on who can gift money to you, what procedures you need to follow, and how to avoid tax penalties.
Who can give you money?
When you think about gift money, you might immediately think of help from a family member like a parent or grandparent. However, down payment gifts can come from a variety of sources. Here’s a little bit about each possible source, as well as what to look out for.
• Family Member. Parents can contribute up to $30,000 jointly, or $15,000 individually, before they have to pay a gift tax. More on this below.
• Friends and Employers. Although not usually permitted with conventional loans, FHA, VA, and USDA loans allow friends and employers to contribute up to $15,000 (before they must pay a tax). Be sure to get a letter that clearly defines your relationship. Some employers offer down payment programs as part of their employee benefits or as an incentive to live nearby.
• Government Agency. While most government programs that offer down payment assistance do so in the form of a second mortgage that must be repaid, some state or local agencies offer grants to eligible buyers. Speak to your lender or real estate agent about possible opportunities available to you.
• Private Organizations and Lenders. Some private nonprofit organizations, like Habitat for Humanity, provide or help low-income first-time home buyers source funds for their down payment. Even certain lenders, like Bank of America, have down payment grants available for those who qualify.
What will the lender ask for?
Down payments are designed to show that buyers have a stake in their purchases, that they can demonstrate financial responsibility in the form of the ability to save money, and, perhaps more than anything, that the purchase is an act of good faith. It makes sense, then, that a lender may be hesitant to finance a loan for a buyer whose down payment largely comes from a gift.
Lenders want to know where you are getting your funds from, and will ask to see your bank account statements to verify that you have sufficient funds to begin with. There are two main things a buyer may have to do to legitimize the funds and appease the concerns of lenders: 1) getting a gift letter to document the funds or 2) seasoning the funds to avoid documentation.
Getting a Gift Letter
Like all personal financial aspects required to be disclosed in the mortgage application process, gift funds must be well documented, and the information about their source(s) and intended use must be formally presented to your lender. One form of documentation your lender might ask for is bank statements and deposit/withdrawal slips—possibly from both you the buyer as well as the gift-giver or donor. More often than not, the donor will also be asked to sign a note verifying the purpose of the gift as well as his or her relationship to you in a letter to your lender. This is called a gift letter.
The most important aspect of this letter is proof that the money is a gift and not a loan that needs to be paid back. Why do lenders care so much about the nature of a private gift? They are concerned with your debt-to-income ratio. If homebuyers have additional debt they must repay on top of what’s on the books, it might put them at greater risk of missing mortgage payments, making the loan itself more risky for the lender.
Your lender may provide a template for you to use for the letter, but Quicken Loans lays out the basic requirements on their blog. These include:
• The name, address, and phone number of the donor
• The relationship between the donor and the recipient (parent, friend, employer, etc.).
• The exact amount of the gift
• The date the funds were given
• A statement from the donor that no repayment is expected
• The address of the property being purchased
• The donor’s signature
If you expect to receive down payment help, be sure to talk with your lender early on to avoid potential delays in closing.
If you are concerned about requirements for documenting gift money or just want to keep the application process simple, you can “season” the funds in your bank account and avoid the whole ordeal. Just as green firewood must sit for a year before it’s ready to use, letting large deposits sit in your bank account for more than two or three months puts it out of the range of time for which your lender usually requests monthly statements. In other words, they probably won’t ask to know about the source of the money, and that allows you to bypass the gift letter process. Seasoning funds is often recommended for these purposes.
Will you have to pay taxes?
The short answer is no. You, the buyer, will not have to pay tax on the money given to you for your down payment. However, that might not be true for the person or entity giving you the money. As mentioned above, if that amount doesn’t exceed $30,000 when given jointly by two parents, or $15,000 when given individually by one parent, family member, friend, or employer, they won’t have to pay taxes, either.
But if the gift is larger than that, the annual limit of $15,000 per person on gifts might apply. In this case, it is still possible to avoid the gift tax. As My Mortgage Insider explains, that down payment gift could instead be applied to the $5.6 million lifetime maximum for gifts rather than the $15,000 per year cap, thus avoiding gift taxes altogether.
Just One Part of the Equation
Of course, not everyone who is struggling to come up with funds for a down payment is fortunate enough to receive or qualify for gift money or grants—and even those who do receive a gift may find they still are unable to get to the desired 20% down payment or cover closing costs. Fortunately, there are numerous programs and loan products out there, specially designed for first-time homebuyers.
Our Guide for First-Time Homebuyers in Marion County walks you through the basic steps to securing funding for your first home. Additionally, check out HUD’s guide to homeownership programs in Florida, as well as Florida Housing Finance Corporation’s (FHFC) wizard for finding Homebuyer Loan Programs, where you can find programs specific to Marion County. Lastly, eligible buyers in Marion County can work with Florida’s State Housing Initiatives Program (SHIP) for funding assistance and homeownership education.