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How to Use Gifted Equity as a Down Payment for a Purchase or Sale

Senior couple with adult children at home

Remember your childhood when Monopoly game night was a thing. The family would gather around the living room fighting for real estate properties that offered the highest return. You’d competitively build an empire of hotels on Park Place in hopes of making Mom go bankrupt. Not that you had to since Moms often let their children win Monopoly.

Fast forward to real life. Mortgages and real estate. Earning equity on your owned property. Only in real life, rather than using it against your loved ones, you can (in fact) use it to their benefit.

It’s as simple as gifting home equity for a down payment. One of the few gifts adult children can truly appreciate in more ways than one.

What is gifted equity?

The difference between the market value and what you pay is considered equity, and it can be used for a down payment. To access equity, Mom and Dad, or any relative can sell you a property for less than its sale price. A relative — in this case — is defined as the borrower’s spouse, child, or another dependent, or by any other individual who is related by blood, marriage, adoption, or legal guardianship; or a fiancé, or domestic partner.

Sound too good to be true? It’s not. Home values are on the rise nationwide, especially in markets like Denver, Seattle, and Portland. So, it’s possible your parents or relatives have some high equity to share if you are interested in purchasing their property.

How it works

First things first, you’ll need an appraisal.  Say the home appraises for $330,000, but your parents are willing to sell it to you for $300,000. That’s an equity gift of $30,000, which is luckily 10% of the home value or a reasonable down payment. It’s then up to you to be approved for a $300,000 mortgage.

Keep in mind, there is no limit to how much equity can be gifted. So, if your parents could sell you that same home for $264,000, you’d have $66,000 in gifted equity. That equates to an even more attractive 20% down payment. The more you’re able to put down, the less mortgage you need to take out. You can even avoid monthly mortgage insurance costs. In other words, you’re continuing to get even more savings.

Learn: What assets and savings are needed to buy a home?

Gifted equity requirements

It's important to note the following requirements if you decide to gift equity.

  • Must disclose the relationship between the seller and buyer.

  • A gift of equity letter must be included in the loan file, and it should clearly state the monies are not a loan so there is no repayment involved (hence the phrase “gifted money”). The letter should be signed by the buyer and the seller.

  • Funds must also be properly documented through financial records. So, be prepared to provide copies of your recent bank statements, your donor’s recent bank statements, and copies of cashier’s checks.

FAQ about gift equity

How much can you give?

Per the IRS, sellers must follow guidelines when gifting equity. Those who fail to do so properly will likely trigger a gift tax. We'll discuss potential tax scenarios later in the article.

How do I calculate it?

Many buyers and sellers assume they'll need a gift of equity calculator to determine final numbers. Thankfully, it only takes a few seconds to come up with your gift of equity amount. Just take the difference between the market value and the sales price and you're ready to move forward with the transaction.

Can you gift equity on an investment property?

Yes. According to Fannie Mae, gifted equity can be used for a primary residence or a second home, such as an investment property. 

Not sure how to finance your investment property? We can help!

Choosing the right mortgage

Once you have a general idea of how much money you’ll have for a down payment, it’s time to start thinking about loan programs. After all, each has different benefits and their rules for gifted money can vary. Let’s take a look at some of the most popular loan programs and what their guidelines look like.

Conventional

If you choose to put down 20% of the purchase price or more, it can all come from a gift. If you put down less than 20%, then only some of the money can be gifted. You’ll have to put down your own money and will have to be prepared to pay monthly mortgage insurance.

FHA

An FHA loan requires a 3.5% down payment, but 100% of it can be covered by a gift of equity — there’s no rule requiring you to put down your own money.

VA/USDA

Since VA and USDA loans do not require a down payment, gifted equity isn’t needed.

Understanding capital gains

Remember, your newly purchased home was likely appraised at market value and your parents probably sold it to you for a good price. If you choose to sell the home quickly after purchasing it, and you sell it for more than you paid, you will likely face a capital gains tax. It works like this: if you sell an asset — in this case, your home — after owning it for more than a year, any gain you have is a "long-term" capital gain. If you sell an asset you've owned for a year or less, though, it's a "short-term" capital gain. And the tax bite from short-term gains is significantly larger than that from long-term gains.

So, if your parents sold you the house for $150,000, and you turned around and sold it for $250,000, you’d owe capital gains taxes on that $100,000 profit.

Tax implications

Depending on the amount of money and where it’s received from, there may be tax implications with down payment gifts. Talk with a financial advisor or tax professional to learn more.

When you’re ready to learn more about loan programs to finance your new home, be sure to contact the mortgage consultants at American Financing. We can get you through the mortgage process quickly and efficiently while offering the lowest rates, best service, and fastest closings. Plus, we would be happy to discuss a gifted equity mortgage as it relates to your situation.

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