Soon after you receive your loan pre-approval, expect to see documents for a conditionally approved mortgage. One condition might be for you to obtain a gift letter. This happens when someone helps you make your purchase, typically by chipping into your down payment cost.
If someone else is helping you, it’s best to ask for the financial support well in advance. Deposit it. Let it season in your account for more than two (preferably three) account statements. This way, when your mortgage specialist asks to see the standard two months of bank statements, the money will be nothing new.
But if the gift transfer is on your recent bank statements, your mortgage specialist will request an explanation. How did that cash infusion get to your bank account? What is the source of the funds?
In short, you’ll need a gift letter.
What a Gift Letter Should Contain
The gift letter is a straightforward, one-page statement laying out the key details of the money transfer. Your mortgage specialist will give you a template for the letter. Save bank records: an image of the check and the transfer from the gift donor’s bank account.
Your mortgage specialist may request all documentation tracing the transfer, and may also ask for a bank statement from your donor. Why? The lender wants to see the history of the funds in the account they came from. This indicates that the money has been legally obtained.
Mortgage lenders require certain details in the corresponding gift letter, such as:
- A title at the top, clearly presenting the document as Gift Letter.
- The donor’s name, complete address and phone number, and relationship to the borrower. Who is most often eligible? Any individual related by blood, marriage, adoption or guardianship, engagement, or domestic partnership. Not any party involved in the real estate transaction.
- The amount of the gift.
- The address of the home to be purchased.
- The gift donor’s source of funds: the name of the financial institution; account number and what type of account it is; and the date on which a bank check to the was (or will be) transferred to the mortgage applicant’s escrow account.
- The dated signatures of the gift donor and home buyer.
Most important of all: The donor is signing a statement that no repayment, either in money or services, is expected. The lender needs to be sure (a) you’re not assuming another debt when receiving the funds; and (b) your gift donor has no lienable claim against the property.
There is a common-sense explanation for (b). You just need to think like a lender to recognize it. The lender, who has to avoid risk, could easily imagine a dispute over the money at some point after closing. What if the dispute led to the person who gave you the money making a claim on the house title? A gift letter demonstrates that the donor is just that — and has no vested interest in the value of the house.
Why a Gift Letter Must Be Truthful
If you have to pay the money back at some later time, it isn’t a gift. The underwriter needs to count it as debt in your debt-to-income (DTI) ratio.
No strings attached? Then the donor should agree to fill out a gift letter. At the bottom, there will be a space for both donor and recipient to certify their understanding that it is a federal crime, with serious penalties, to knowingly misrepresent their intentions.
If you intend to pay this money back, do not submit a gift letter.
An unsecured loan is never allowed to fund a down payment. Do not use one by fudging a gift.
Here, a borrower might ask how anyone would know. And how would anyone possibly charge a donor or recipient with a federal crime once the deal is over?
It does happen. People have job losses, family emergencies, medical events, and other incidents that lead to financial setbacks. Some loans fall into mortgage default. Some homeowners face foreclosure or bankruptcy. In the unfortunate event of legal action, courts will examine documentation the homeowner used to get the mortgage. And if misrepresentations were made, they will come to light.
Do All Loan Types Allow Gifts for the Whole Down Payment?
Speak with your mortgage specialist about the best kind of loan for your situation, including your intent to use gift funds. For a basic idea, the popular types of loans apply these standards:
- Conventional loans through Fannie Mae and Freddie Mac: A gift from a relative can fund the full down payment for a primary residence. Freddie Mac also allows loan applicant to use recent wedding gift money from friends and relatives.
- The Federal Housing Administration (FHA): A gift of cash is acceptable from a relative, union, employer, close friend, or nonprofit organization. The money can also be sourced from a public entity that supports first-time home buyers or low- to moderate-income buyers.
- Department of Veterans Affairs (VA) and U.S. Department of Agriculture (USDA) loans: VA and USDA loans technically don’t require a down payment. Gifts and gift letters are nevertheless commonly allowed to fund down payments for these purchases.
In short, most mortgages allow for gift money to fund the full down payment on a primary residence. Lending rules are stricter for the purchases of investment properties.
Pro tip: Your lender may also permit you to use gift money for mortgage reserves, if you are applying for a conventional loan. Gift money over and above what’s needed for the down payment may be directed to reserves in an FHA loan. Ask your mortgage specialist or loan officer for current information to suit your own situation.
Tax Considerations for Gift Donors
If giving over $15,000 ($30,000 for joint filers) to any one recipient, the donor has to declare the gift to the Internal Revenue Service. When filing tax returns for the year the gift letter was signed, the donor should use the federal gift reporting form to report the transfer of funds.
The donor won’t pay tax on the gift money. But giving does have tax ramifications, at least on paper. It is subtracted from the lifetime gift amount a person may give tax-free. So, the donor will want to check with a tax professional for guidance.
A Few Final Words to the Wise
Once you have your conditional approval, avoid making big deposits into your accounts (such as an unusual deposit of over half your monthly income) until after you close on your new property. Note that lenders reexamine your assets if 60 days go by since they first reviewed your two months of bank statements. Large deposits into your bank account are also triggers.
It’s good to use a gift (and a gift letter) only if you really need it to get a loan. It’s also good to understand the gift letter’s purpose from a lender’s point of view. This understanding can help you steer clear of legal problems. It can also help you get your final mortgage approval…right on time.
Supporting References
18 U.S. Code § 1010: Department of Housing and Urban Development and Federal Housing Administration Transactions.
18 U.S. Code § 1014: Loan and Credit Applications Generally; Renewals and Discounts; Crop Insurance.
Denny Ceizyk with Deborah Kearns (ed.) for LendingTree.com: Gift Letter for a Mortgage Down Payment (updated Dec. 27, 2020).
And as linked. Photo credits: Karolina Grabowska and Brett Sayles, via Pexels.