Buying a home is a special milestone for many, but it’s not one that’s easy to achieve for most. First-time buyers trying to get on the ladder come up against one major hurdle – getting the down payment together.
Saving for a down payment whilst also paying rent and other living expenses is a long and tough process for a lot of people. That’s why so many rely on the help of family to give them a boost. Having family members who can add to the down payment is a huge help.
This, paired with a Federal Housing Administration (FHA) loan, makes homeownership much more achievable for those on lower incomes.
However, if you are looking to apply for an FHA loan, you need to read up on the rules of FHA gift funds. The FHA has strict guidelines on what will and won’t be accepted as a gift fund towards the down payment.
What Does the FHA Consider to be a Gift Fund?
The FHA defines a gift as a contribution of cash or equity with no expectation of repayment. In other words, if a friend or family member gives you money for the down payment, it cannot be a loan.
You also can’t try to cover up a loan by calling it a gift as this could be against the FHA gift funds rule.
FHA Gift Fund Rules to Know About
Other than the fact that it needs to be a gift rather than a loan, the FHA has restrictions on:
- How gift funds can be used
- Who can give funds and who can’t
FHA Gift Fund Uses
FHA gift funds can only be used to cover certain payments in the house purchase. The main ways you can use them include:
- As part of the down payment
- FHA closing costs
- Financial reserves needed for approval of the loan
FHA loans usually require a down payment of 3.5% or more of the purchase price. This means that if your down payment is entirely funded through this gift, it must be at least 3.5% of the purchase price.
Who Can Give Gift Funds?
You can’t receive a gift fund from just anyone. The FHA and lenders typically have restrictions on who can and can’t give gift funds. Gift funds can be provided by:
- A relative
- Employer or labor union
- A close friend with a clearly defined and documented interest in the borrower
- Charitable organization
- A governmental agency or public entity that has a program providing homeownership assistance to low or moderate-income families or first-time homebuyers
Whoever is involved in giving this gift should have a clear reason for doing so, otherwise, lenders or the FHA may believe that it’s a loan in disguise. It’s also essential that whoever is providing the gift is not involved in the transaction of the property purchase. It can’t be a seller, lender, realtor, or builder.
How Does a Gift of Equity Work with an FHA Loan?
Another way someone can provide an FHA gift fund is through an FHA gift of equity instead. This is when a family member sells you their home but gives you a discount on the purchase.
With a gift of equity transaction, the family member sells the home for the current market rate but then removes the gift of equity portion which is counted as a down payment credit.
Here’s an example:
Purchase price: $300,000
Gift of equity 3.5% down payment: $10,500
FHA loan amount: $289,500
This could mean that buyers essentially can purchase a home with no cash down payment thanks to the seller’s discount. This is providing the equity is enough to cover the 3.5% minimum requirement.
Who Can Give a Gift of Equity?
Rules over gifts of equity are a bit more strict than simple gift funds. They must only come from family members. So, a family friend, employer, or charitable entity can’t give a gift of equity on an FHA loan.
The Next Steps
To complete an FHA purchase with a gift of cash or equity, you need to draw up an official gift letter. The gift letter must include the following information:
- Donor’s name, address, & phone number
- Their relationship to the borrower
- Amount of the gift
- A statement that repayment is not necessary
- Borrower(s) and donor(s) signatures with date
- Copy of the gift check
- Evidence that the borrower has received the gift funds or evidence given to the closing agent
- Donor bank statement showing a gift withdrawal transaction
5 FHA Gift Fund Tips
- Do not gift cash
- Document the funds
- Talk to your family member about the terms of the gift to confirm that repayment is not necessary
- Gift funds may be used in conjunction with down payment assistance programs
- Most importantly, discuss options, requirements, and solutions with your loan officer.
We have a formal FHA gift letter that you can use, but you can write up your own if you prefer. You just have to make sure the above requirements are included.
Whether you go down the cash or equity route, make sure that you document all funds and transactions and ensure that all requirements are made clear to both parties. This is where it helps to speak with one of our licensed loan officers as they will be best placed to advise you on the next steps.
Get help with your FHA loan application from our expert team.