Are you buying a home from a family member? Family transactions may have advantages for both the buyer and seller. A major benefit to buyers is a gift of equity. So, what is a gift of equity? It is a little-known rule which allows equity in a family member’s house to be used as the buyer’s down payment. The seller passes along part or all of the equity in the house to the buyer. FHA guidelines, among other mortgages, allow the seller to pass along equity as a gift, but it must be done correctly.
Buyer Benefits of a Gift of Equity Purchase
Finding the right house and learning everything about it can be a daunting task, but what if you have known the sellers and the property forever? On top of that, what if the seller will help you out with the down payment? This could be quite the win-win! Although there are wonderful low to no down payment financing options, a gift of equity scenario could be quite the plus.
If you have a potential interest in buying a family member’s home contact us now. You will need a lender and loan officer who can walk you through the correct steps for gifts of equity. Even if you are receiving a monetary gift from family, there are strict procedures for this.
Do you still want to look at other houses? Ask us for a referral. We work with several realtor partners that would be an excellent resource for your home search. Also, see which realtors do a great job in your area on such resources as Zillow or Trulia.
Why Would Sellers Give a Gift of Equity?
Besides the fact the buyer is family, there are seller benefits to passing along the equity in the home as a gift. First of all, family transactions typically do not involve a real estate agent. Therefore, the seller saves up to 6% in commissions paid. Rather than pay a commission, how about passing it along as equity or down payment for your family member? Plus, there may be the benefit of a quicker sale rather than waiting for a buyer.
While calculating the price and the seller’s net, there are costs to keep in mind. These costs vary by state so ask your lender or real estate attorney. Typical seller side costs could include the following:
- Mortgage payoff(s) including home equity loans
- Prorated property taxes for the current year
- Deed preparation
- Transfer taxes and deed stamps
- Judgments or liens against the property
- Contract preparation fee by the attorney (if applicable)
Although there are benefits for sellers, there could be some potential disadvantages. Since there is not a realtor, someone will need to prepare the purchase agreement. Since it is a legal and binding contract, we suggest hiring an experienced real estate attorney. Typically, the seller pays this fee in lieu of paying a realtor, and we see contract prep fees in the range of $150 – $200. However, you complete the contract, involve your mortgage professional. There is specific language required in a purchase contract and especially in these scenarios.
Furthermore, it is important to speak with your tax professional. Make sure to ask about any potential tax implications. Gifts of real estate could trigger an IRS gift tax.
Gift of Equity Requirements
Here are some of the main requirements for these family transactions.
- The contract must include specific language:
- State the relationship of the parties
- Gifted equity amount
- Any seller paid closing costs
- Completed and signed gift of equity letter. We provide the gift letter
- Close family member
- Equity in the property
Gift of Equity Letter Requirements
Besides the required family relationship, the gift letter is very important. Mortgages have specific requirements for terminology in gift letters. The gift letter must show the donor’s name, address, phone number, dollar amount of the gift, the relationship between the borrower and the donor, plus state that no repayment is required. Here is an approved gift letter format.
Here’s another important tidbit. A gift of equity is not allowed when the seller is an estate. This is even true when the buyer is family of the deceased. To use a gift of equity, see the deed requirements for an estate. Even if a gift of equity may not work out in this case, there are plenty of other ways to buy from an estate.
Options other than FHA for Gift of Equity
FHA has many positives for buyers including the option to keep collections open. Although, FHA is not the only loan program which allows for this gift. Conventional mortgage guidelines allow this as well. If the property has a lot of gifted equity, this may be the preferred way to go. For instance, if there is 20% equity, then the buyer could avoid PMI. Then the mortgage payment is lower and saves money each month. FHA always requires PMI, even if the loan amount is under 80% of the price. It is also possible for a family member to buy a home from another family member for a second home. The down payment for the second home purchase could be in the form of a gift of equity but only if the equity is 20% or more of the price. This could result in buying a second home with none of the buyer’s funds for down payment. Check out our article that shows how “Buying a Second Home is Easier Than You Think.”
What if there is no equity in the property to gift? Then let’s talk about some no money down options. Recent USDA income limit increases help even more buyers qualify for a no money down purchase. Plus, USDA has another advantage over FHA which is a much lower monthly and up-front mortgage insurance amount. Thus, it could keep the payment lower. Another no money down option includes VA home loans which are available to service members, Veterans, and qualified surviving spouses.
If considering buying a home from family, give us a call.