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Mistakes To Avoid If You're Struggling With Your Down Payment

Brian Kline

So many first-time buyers struggle pulling together the down payment that gifted money from relatives and close friends has become relatively common.

The practice is no longer prevalent only among wealthy families.

Now that gifts for down payments are more common, the requirement for a gift letter and formatting requirements have also become stricter. 

Why Is A Gift Letter Required?

Real estate purchases require large amounts of money. As you can probably guess, when large amounts of money are involved, people look for ways to skirt the rules or take shortcuts.

Relying on gifted money is no different. The primary purpose of a gift letter is for your lender to verify that you aren’t required to repay a loan disguised as a gift.

A loan that must be repaid can significantly affect your debt-to-income ratio, which is an important part of your loan approval.

You will be taking on a large debt obligation with your new mortgage. If you will also have to repay a borrowed down payment, the lender could be at risk if you don’t have enough income to pay both at the same time.

Human nature is for people to take care of obligations to relatives before paying financial corporations: families have dinner with each other at Thanksgiving, not banks.

That's why your lender requires a properly documented gift letter making it clear the money doesn’t need to be repaid.

How Much Can A Down Payment Gift Be? 

This might surprise you, but different types of loans have limits on how much gift money you can receive toward your down payment and closing costs.

The variation is significant enough that it could be a deciding factor in the type of loan for which you apply. 

For instance, most Fannie Mae- and Freddie Mac- backed loans allow the entire down payment to be a gift as long as you are putting down at least 20% on a single-family residence.

The type of home you are buying also makes a difference. If you are buying a multi-unit home such as a duplex or four-plex, at least 5% of the down payment must come from your own funds.

In all scenarios, the person gifting you the money must provide a gift letter.

The good news is that FHA and VA loans allow the entire down payment to be made with gift money, with the caveat that your FICO score must be 620 or above. 

For lower credit scores, the rules change and generally, you’ll need at least 3.5% of your own money.

Gift Letters Benefit Your Relative Or Friend

There may or may not be tax implications for the donor. As the homeowner receiving the funds, there should not be tax implications for you.

The reason that your donor could face tax consequences: the IRS limit on gifting money.

The limit applies to each person receiving a monetary gift. For instance, if your parents file a joint tax return, the total amount they can gift to each child is $30,000 for 2019.

When that amount is exceeded, taxes can be owed by the donor. Other relatives, such as grandparents, have lower allowable limits.

It’s always wise to talk to a donor about the possible tax implications before the gift is made and before the gift letter is written. The bottom line is that you should not count on gift money without knowing the rules. You also need to know the rules applying to the gift letter before the money is deposited into your account.

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