Buying a home with an FHA loan is an excellent financial decision, but it can be incredibly expensive. Many people rely upon friends or family to assist them in raising closing costs or a down payment, which is called a gift fund.
It’s essential that you and the gift-giver follow the rules so that you don’t run into trouble during the home-buying process. Let’s explore what gift funds are, the rules governing their usage, and how to properly document your gift funds.
What Are the FHA Lending Requirements For Home Purchases?
First, let’s talk about what exactly FHA home loans are. An FHA loan differs from conventional loans because the Federal Housing Administration will back the loan, ensuring that the mortgage lender will not be out of money if the borrower defaults.
These loan programs make a home purchase more attainable for those with low credit, a high debt-to-income ratio, or limited funds, as there are less rigorous requirements when it comes to credit score limits.
That being said, there are still some FHA loan requirements, which include the following:
- The home must be the borrower’s primary residence.
- The borrower must move into the home within 60 days of purchase.
- The home must pass an inspection.
- The borrower must pay a mortgage insurance premium.
- An FHA-approved appraiser must assign the home a dollar value.
- Borrowers with a credit score of 580 or higher must provide at least a 3.5% down payment of the loan amount.
- Borrowers with a credit score of 579 or lower have a 10% down payment requirement.
It’s important to note that the Federal Housing Administration is not the FHA loan servicer: FHA loans are serviced by mortgage lenders, just like a conventional loan would be.
The FHA works with approved lenders by promising that they will pay back the loan if you default, but you still need to be approved for the loan itself by a lender. You can apply online to see if you qualify.
How Are FHA Gift Funds Defined?
FHA gift funds are a financial gift that home buyers can use for closing costs or down payment. They are given to you with no expectation of repayment. In other words, they are not another loan that you take out with someone else: they are a genuine gift given to you by a person or entity with a dedicated interest with you, not a financial interest.
For home buyers with a lower credit score, gift funds can be a vital component of the borrower’s ability to purchase a home; even a relatively modest home that costs $80,000 will have an upfront cost of $10,500 or more.
What Are the HUD Guidelines For Gift Funds?
There are a few different guidelines on FHA gift funds set out by the Department of Housing and Urban Development (HUD), which include the following:
- The funds must be verified with bank statements as leaving the donor’s bank account and entering the borrower’s bank account.
- The funds must come from an approved source, including savings accounts, stocks (ie, selling off stocks to give money), or a savings bond.
- The donor must provide documentation proving that the gift money is not a loan.
FHA gift funds can be in any amount, though the donor will have some tax implications if they give more than $16,000.
Who Can Provide Gift Funds?
FHA guidelines are strict on who can be a gift donor; this is primarily to avoid conflicts of interest for the buyer. Fortunately, the FHA has provided clear guidelines, and they cover a relatively large span of situations and donors.
Acceptable Gift Donors
The following individuals or entities are allowed to provide gifts for a home purchase:
- Family members with a dedicated interest in your life, including cousins, nieces, and nephews
- A close friend with a defined interest in your life
- A charitable organization
- The borrower’s employer or labor union
- A governmental agency dedicated to providing financial assistance to first-time homebuyers
Unacceptable Gift Fund Donors
On the other hand, these entities cannot donate for FHA loans:
- Property sellers, unless they are a relative providing a gift of equity
- A family member like a cousin, niece, or nephew with no defined interest in your life
- Mortgage brokers or lenders
- Home builders
- Real estate agents
What Is a Gift of Equity?
A gift of equity refers to when the donor sells you the home at a loss – in other words, for a sum less than what it is worth. For example, imagine that you’re buying a $100,000 home, but your purchase price is $80,000. There would be a $20,000 gift of equity, which would then be used to pay the down payment or closing costs.
Under the HUD guidelines, only relatives can provide a gift of equity.
What Can Gift Funds Be Used For?
Gift funds can only be used for specific elements of the home-buying process, which include the following.
Down payments: For an FHA loan, you need either a 3.5% down payment credit (for borrowers with a credit score of 580 or higher) or 10% down (for borrowers with a credit score of 579 or lower).
Closing costs: These can be anywhere between 3% and 6% of the total loan cost.
Cash reserves: Cash reserves are unexpected costs related to the home-buying process.
FHA funding fees: Up-Front Mortgage Insurance Premiums (UFMIP) are a form of protection for the lender, which you will have to pay at closing.
You cannot use gift funds for monthly mortgage payments or to pay your Mortgage Insurance Premium (MIP), which is considered part of your monthly payment.
Pros and Cons of FHA Gift Funds
Gift funds can be an essential element of the home-buying process for many people, but there are some downsides as well. Here, we’ll discuss the benefits and drawbacks of using FHA gift funds.
Pros of Gift Funds
Reduces your financial burden: If you’re applying for an FHA loan with a low credit score, your down payment will be 10% of the overall cost of the home; this doesn’t cover closing costs, which can be as high as 6%. This is a considerable amount of money for many people, so receiving gift funds can make it easier to pay the money upfront.
Cons of Gift Funds
May disqualify you from a loan: The Automated Underwriting System used by mortgage lenders tends to view receiving gift funds unfavorably, particularly if they are used to pay 100% of the down payment and closing costs.
It’s important to note that this doesn’t mean that you’re not eligible for FHA loans overall – just that the specific FHA lender who is approving you for the mortgage may deny you if you’re using gift funds.
If you’re denied FHA loans due to gift funds, you might be able to use them if the donor adds you to a joint checking account and pays that way.
What Supporting Documents Do You Need for FHA Gift Funds?
In order to use gift funds, you need two things: a gift letter and financial documents proving that the transaction was legitimate. We’ll discuss exactly what you need to show to prove that you can use your FHA gift funds.
Details Included in an FHA Gift Letter
The FHA gift letter is from the donor, confirming that this is not a loan and that it was intended for the purchase of your home. Gift letters should include the following information:
- Recipient’s name
- Donor’s name
- Donor’s relationship to the recipient
- Address of the property being purchased
- The exact amount of the gift money, as well as its source
- Declaration that the money is not a loan and does not need to be repaid
- Dated and certified signatures from both donor and recipient
You will also need to prove that the money left the donor’s account and entered the borrower’s bank account in order through bank statements. The amount being declared in the gift letter must exactly match the financial statements.
It doesn’t matter whether this comes from a business account or a personal account, just that it can be proven that it is a gift and not a loan.
There are two different ways that you can identify this, depending on how the money was given to you.
For Electronic Transfers
The home buyer must provide a deposit slip that exactly matches the gift amount; the donor must provide a withdrawal statement that matches what the borrower receives. You can find the deposit amount on your bank statement.
For Cashier’s Checks or Certified Checks
The borrower must provide a copy of the check which was deposited in the bank; the donor must provide a copy of the canceled check. Again, both must match the amount.
You cannot use cash for gift funds. Instead, the donor should deposit the money in their own account and send it to you through Electronic Funds Transfer, or they should write a check. There must be a paper trail.
In summary, gift funds used for FHA loans must meet specific requirements, and they must be accompanied by a gift letter.