Can you imagine how exciting the gift of a home would be? We’re not talking a plastic playhouse or an elaborately crafted dollhouse wrapped up in a bow, either – we mean a real house. While it may seem far fetched to some, it’s not all that uncommon, and can be done using a gift of equity.
What is equity, you ask?
To understand a gift of equity, we need to first talk over the concept of equity itself. Equity is the appraised value of your house minus the remainder of what you owe on your mortgage. For example, if your home is worth $300,000 and you owe $200,000 on the mortgage, you have $100,000 in home equity.
A gift of equity comes into play when a family member’s (the seller’s) equity in their property is gifted to act as the buyer’s down payment. Depending on the amount, this may cover the entire down payment or serve as a contribution to the money a buyer already has saved or available.
This is also one way that a house can be sold for under market value to a family member, which can allow for a buyer to purchase a better home in a nicer area than they might otherwise be able.
What does this look like?
Jim and his wife, Pam, are outgrowing their one-bedroom apartment, and they are ready to buy a home. After meeting with their loan officer, they find out that they are preapproved for a $250,000 loan. Jim and Pam are excited to begin their house hunt, but after looking at several homes, they can’t find anything that they love in their price range.
Jim’s grandfather, Dwight, lives in the home he built and raised his family in. He has been considering downsizing for some time but hates the idea of selling his family home to a stranger. After talking to Jim and learning that his grandson was looking to buy a forever home, Dwight has an “ah-ha!” moment.
A gift of equity is the solution.
Dwight knows that his home is worth $300,000. He owes $200,000 on the mortgage and has $100,000 in equity. He can sell the family home to Jim for $300,000 and gift $50,000 of his equity to serve as Jim’s downpayment. This is a win-win for both Jim and Dwight. The $50,000 gift means that Jim won’t a cash down payment AND he can stay within his budget!
Dwight gets to downsize without having to sell his family home to a stranger, and because he was planning on leaving Jim a bit of inheritance already, he considers the $50,000 gift as part of his legacy. With the remaining $50,000 of equity in the home, Dwight can keep some cash for his own move to a smaller condo (or whatever else he may want to do.)
The main benefit of a gift of equity is for the buyer.
As you may have learned, the buyer benefits the most from this transaction. Receiving a house for below market value and/or having your down payment covered is no small thing!
But there are actually benefits to the seller, too. These include a quicker sale (because they already know who is buying their home, they don’t have to wait around with their house on the market indefinitely) and the possibility of keeping a well-loved home in the family.
Another possible benefit (though not limited to gift of equity scenarios) is that, because this type of transaction does not have to involve a real estate agent, the seller may save up to 6% in commissions paid. For example, if a house is $250,000, the savings can equal out to $15,000 kept in-pocket!
Keep the following requirements in mind…
To use a gift of equity, you will need a contract including specific language, stating:
- The relationship between the parties
- Gifted equity amount
- Any seller paid closing costs
You will also need a completed and signed gift of equity letter. Mortgages have specific requirements for terminology in gift letters. A complete gift letter contains:
- The donor’s name, address, and phone number
- The dollar amount of the gift
- A statement that explains the relationship between borrower and seller
- Verbiage that states that no repayment is necessary
Here is an approved gift letter format that you can use to get started! Finally, there must also be equity in the property. This is an obvious requirement – you can’t give what you don’t have.
Two more things to note:
- The gift of equity is subject to the appraisal.
An appraisal does two things; it prevents a buyer from overpaying and is also for a lender to help protect the value of a home. While the seller may believe their home is worth $750,000, it may only appraise for $500,000. This is important because if a family member plans to sell the home for 450,000 using a gift of equity, the gift will be $50,000 and not $300,000.
2. A gift of equity is not allowed when the seller is an estate.
This may seem confusing at first, but we can help you through the entire process from start to finish. If you are considering buying or selling a home utilizing a gift of equity, reach out to our team today!