If you are ready to buy a home but don’t have enough funds for a down payment, getting cash from a parent or relative can make a huge difference. And if you’re lucky enough to be in such a position, you’ll need a gift letter.
Simply put, a gift letter is a letter written by the person who gave you money verifying that it was a gift and that you don’t have to repay it. The lender is then able to put the amount you received towards the down payment for a mortgage.
Particularly when inflation, housing prices, and interest rates are all rising, a gift may be the only way for young and first-time buyers to purchase a home. But exactly how do gift letters work?
When a Gift Letter is Needed
When you apply for your mortgage, you must provide your lender with some required documents, including bank statements, pay stubs, and any other forms of income to support your application. If you have little or no cash reserves or savings to make a down payment, your mortgage application may be declined.
However, if a qualified donor, often a family member, offers to give you money towards the purchase of your house, you have more options. With those extra funds, you could bring your loan-to-value ratio down to 80% so you can get a better interest rate and avoid paying for private mortgage insurance (PMI).
That being said, a monetary gift is only allowed if you can prove it is truly a gift. For that reason, lenders require you to submit a gift letter to verify that the cash you receive is not a loan. If the money is a loan, it changes your debt-to-income ratio, which impacts your ability to qualify for a loan. In fact, most lenders prefer that you receive any down payment funds as a gift and are reluctant to allow cash loans as down payments.
Do you need to report gifts of any amount? Typically, for conventional loans and VA loans, lenders require an explanation for any gift you receive that’s over half the value of your total household monthly income. For instance, if you earn $5,000 a month in income, lenders require a letter for any gifts you receive that are more than $2,500. With USDA or FHA loans, you will need an explanation for deposits that are larger than 1% of the adjusted purchase price or appraised value of your new home, whichever is larger.
What Do I Need to Do?
There are specific requirements for gift letters depending on what type of loan you get. For example, on Fannie Mae and Freddie Mac loans, gifted funds are typically only allowed from family members and for owner-occupied primary homes or second homes. For FHA, USDA, and VA loans, gift funds may come from family members, as well as employers, labor unions, charitable organizations, government agencies or public entities that provide help to first-time homebuyers. The only exceptions are parties who have a vested interest in the sale, such as a real estate agent or the seller of the home.
A gift letter must include the amount being gifted and state that no amount of the gift is expected to be repaid under any circumstances. The donor must also disclose their relationship to you and where the cash is coming from, whether it is from their bank account or investments.
The letter must be in writing, not an email, and be signed by the donor. Once you submit the letter to your lender, the lender will verify the source of the cash and ensure there is no collusion between the parties that are facilitating the purchase. It’s also important to work closely with your lender to find the right loan for your situation and allow them to guide you through the gift letter process.
Are you thinking of buying a home and have more questions about gift letters? Our Loan Officers at Right By You Mortgage will be happy to help. Just give us a call at 1-877-552-2242 or drop us a note at inquiries@rightbyyoumortgage.com.
