Learn the basics of mortgage gift funds: who can receive, who can give, differences in rules across loan programs, gift letters, and tax considerations.
Many homebuyers, especially first-time buyers, may find the down payment as one of the most difficult parts of the process. It’s typically the largest expense associated with buying a home. But there’s good news! Homebuyers can use money received as a gift, known as a mortgage gift fund, to put towards the down payment on a home.
Each loan program has different rules regarding gift funds. Let’s review the basics.
What are mortgage gift funds?
Any amount of money given to a person to help them with a home purchase is considered to be a mortgage gift. It’s money received in addition to the buyer’s normal income.
Mortgage lenders look very closely at homebuyers’ finances during the underwriting process to determine whether it is worth the risk of lending them money. If a homebuyer will be using gift money in the purchase, lenders need to know. Lenders have developed sets of rules regarding who may provide a mortgage gift to a buyer, how much of a down payment can consist of gifted funds, and how a buyer must document the gift.
Who can provide a gift for a mortgage down payment?
Only certain individuals or entities can give gift funds to a homebuyer. The rules vary depending on the type of loan. Across all loan programs, interested parties in the sale of the property cannot contribute gift funds. Interest parties may include:
- The builder or seller of the home
- A real estate agent for the buyer or the seller
- An escrow agent, mortgage broker, or another individual with an interest in the sale
A conventional loan is any mortgage loan that is not backed by an agency of the U.S. government. Their rules on gift funds are a bit tighter than other programs.
Fannie Mae and Freddie Mac limit mortgage gifts for conventional loans to people who are related to the home buyer by blood, by marriage, or by legal processes like adoption or legal guardianship. This also includes domestic partners and people the buyer intends to marry.
The following people may be eligible to contribute gift funds to a homebuyer using a conventional loan:
- Parents or children, whether biological or adoptive
- Grandparents or grandchildren
- Siblings, aunts, uncles, nieces, nephews, or cousins
- A spouse, domestic partner, or fiancé/fiancée
- A court-appointed legal guardian
Loans guaranteed by the Federal Housing Administration (FHA) have slightly different rules. The definition of “family” is narrower, but overall there are fewer restrictions on who may provide a mortgage gift:
- Family members, including spouses, parents, children, and siblings, but not cousins, nephews, or nieces
- Close friends, which could include cousins, nephews, or nieces
- Labor unions
- Charitable organizations
USDA and VA Loans
Home loan programs offered by the U.S. Department of Agriculture (USDA) and the U.S. Department of Veterans Affairs (VA) have the fewest restrictions with regard to mortgage gift funds. Anyone can provide a homebuyer with a mortgage gift as long as they are not an interested party.
Are there limits on the amount of a gift?
For a single-family primary residence, a buyer can usually use gift money for the entire purchase price and closing costs. But a buyer may have to pay a percentage using their own money for second homes or and investment properties.
Can I repay a mortgage gift?
Generally, no. They’re called mortgage “gifts” for a very important reason related to underwriting. Mortgage lenders compare a homebuyer’s outstanding debt to their income. This is called the debt-to-income ratio. If a gift for a down payment is actually a loan itself, the ratio will be incorrect.
If the donor is actually expecting regular payments it would no longer be considered a gift.
What’s a gift letter?
A gift letter informs the lender that they have received or will receive gift funds to apply to the purchase. Both the buyer and donor must contribute to this document.
Different lenders may have their own requirements for what a gift letter should contain and how it should look. Your loan officer will help guide you. At a minimum, it should include:
- The amount of the gift
- The date the buyer received the funds or expects to receive them
- The address of the property
- The donor’s name and contact information
- The relationship between the buyer and the donor
- A statement signed by the donor indicating that they gave the money as a gift and that they do not expect the buyer to pay them back
- A copy of any document or financial instrument showing the completed transaction, such as a deposit slip or confirmation of wire transfer
Will I owe tax on mortgage gift funds?
The donor of a gift - not the recipient - is responsible for paying the gift tax and filing a gift tax return. Federal tax law sets a maximum amount that a donor can give per year without incurring gift tax liability, known as the exclusion amount. It also sets a lifetime exemption that is free of gift tax.
The annual exclusion amount for an individual taxpayer is $15,000 in 2021. For married taxpayers filing joint returns, it is $30,000. These exclusion amounts will remain in effect until at least 2025. The lifetime exemption, as the name suggests, is the maximum amount that a person can give gift-tax-free during their lifetime. Currently, this amount is $5.6 million.
The exclusion amount applies to each gift recipient. A donor with two children, for example, can give $15,000 to each of them without incurring gift tax liability.
A donor who wants to give more than $15,000 to a person during a year could still avoid gift taxes by deducting the amount of the gift from their lifetime exemption. This could pose a problem down the road for a donor with a large estate. If they exceed their lifetime exemption, the IRS could assess taxes on their heirs.
Learn more about your options.
Everyone’s situation is unique. Homebuyers should discuss whether they should accept a mortgage gift with their lender. At The Wood Group of Fairway, we help homebuyers with all kinds of different needs. Get started on your free pre-approval to see which options are available for you!