Do you dream of owning a home but lack the cash for a down payment? Receiving gift funds is a common way to secure financing via an FHA mortgage. Yet, if you receive money for your FHA down payment or closing costs as a gift, you must comply with FHA loan regulations. So, if you’re considering FHA gift funds as a path to homeownership, here’s what you should be aware of.
Understanding FHA Gift Funds
FHA gift funds refer to assets gifted from a donor to a borrower in the form of cash or equity, with no expectation of repayment. These funds can be used by borrowers towards a down payment, closing costs, or housing reserves to qualify for an FHA mortgage.
FHA loans, as non-conforming and government-backed options, are among the various loans available for mortgage financing. They are particularly beneficial for individuals with low to moderate incomes, facilitating their journey towards homeownership.
First-time home buyers with limited down payment funds or those burdened with substantial debt often find FHA loans a viable option. Notably, FHA loans generally have less strict approval requirements compared to conventional loans, including lower credit score prerequisites.
The typical FHA loan criteria are:
- The property should serve as your main residence, and you must move in within 60 days of the closing date.
- An inspection is required to ensure the home meets the minimum property standards.
- Mortgage insurance premium (MIP) is a cost that borrowers are required to cover.
- A home must undergo an appraisal by an FHA-approved appraiser.
- Borrowers with credit scores exceeding 580 are required to make a minimum down payment of 3.5%.
- Borrowers with credit scores ranging from 500 to 579 are required to make a minimum down payment of 10%.
Consider that your debt-to-income ratio, income, and loan amount all influence your eligibility for qualification.
Understanding the Difference Between Gift Funds vs. Gift Letters
Gift funds are monetary gifts given to a borrower to assist with a home purchase. When seeking FHA loan approval, borrowers can utilize these gift funds for a down payment, closing costs, or reserves required for approval. It is a common misconception among buyers that lenders are indifferent to the source of the funds as long as they are available.
However, it is crucial for the lender to ascertain that the homeowner possesses the financial means to meet their regular loan payments. This is where gift letters play a pivotal role. If a gift is intended for a down payment or to cover closing costs, the lender must verify that the funds are not a loan the borrower is obligated to repay.
The U.S. Department of Housing and Urban Development (HUD) assesses each borrower’s loan repayment capacity by examining their financial circumstances. This evaluation involves reviewing financial documentation like pay stubs, bank statements, or W2s. For instance, if HUD identifies a substantial amount of cash within the last two months, they need assurance that it is a gift and not a loan. The purpose of the gift letter is to confirm that the borrower is not obliged to repay the gifted amount, and it is freely available for use in the home purchase.
This letter should be composed and signed, including the donor’s personal details, explicitly stating that the funds were provided as a gift, not a loan.
How to Make the Most of FHA Gift Funds?
Receiving gift funds through FHA can streamline your eligibility for an FHA loan, but adhering to specific criteria is crucial for approval. The funds must be an outright gift, not a loan in disguise, with a clear purpose stated by the donor to differentiate it from a loan. It’s important to maintain detailed bank statements from both the donor and borrower to trace the fund transfer and duration of funds in each account, serving as evidence of asset exchange.
Donors have the option to provide cash or equity as gift funds. While cash transactions are straightforward, equity gifts involve the donor selling their property to the borrower below market value. This enables the borrower to utilize the equity for expenses like a down payment. For instance, if a donor sells a home to a relative for $500,000, though valued at $450,000, the borrower gains $50,000 in equity. This equity can be utilized through a home equity loan or line of credit for purposes like renovations, serving as a down payment credit for FHA loan approval.
Guidelines For FHA Gift Funds
To be eligible for an FHA loan, you need to meet the FHA loan requirements and adhere to the FHA gift fund guidelines. These guidelines encompass specific criteria for gift funds under the FHA framework.
- Gift funds must originate from approved sources like savings accounts, stocks, or savings bonds.
- Gift funds need to be authenticated as they move from the donor’s bank account into the borrower’s account.
- Documentation proving the source of funds is not a collateralized loan, like an FHA gift letter.
Consider that you might need to submit extra supporting documentation based on your chosen utilization of your FHA gift funds.
Who is eligible to provide gifted funds for an FHA loan?
Gift funds for an FHA loan must adhere to specific donor guidelines set by the FHA. Approved donors include:
- Family member of the borrower
- Employer or labor union of the borrower
- A trusted friend with a well-defined interest in the borrower.
- Charitable organization
- A government agency that supports low to middle-income families or individuals purchasing their first home.
You are not allowed to accept gifts from individuals involved in the property purchase transaction. For example:
- The property seller
- Real estate professionals
- Mortgage Lender
- Home builder
Key Takeaway
Securing a down payment for a new home often ranks among the most nerve-wracking aspects of purchasing property. Luckily, FHA gift funds offer a solution.
If a generous individual plans to gift you money for the down payment, closing expenses, or cash reserves, it’s crucial to adhere to FHA guidelines. Additionally, it’s important to ensure a steady income stream to cover your monthly mortgage payments.
Once your finances are in order for the home purchase, the next step is to seek preapproval for an FHA loan.
Reed Letson
Reed offers two decades of expertise as a mortgage broker, focusing on veterans and first-time home buyers. With a strong grasp of real estate and mortgage markets, he empowers clients with practical insights. Reed's passion is guiding clients to build wealth through real estate investments and financing solutions.