Gift Of Equity Conventional Loan

When homeowners transfer their residence to a close relative, they might want to do so at a reduced price. In this case, the seller gives the buyer a gift of equity in the amount equal to the difference between the home’s market value and the sale price. The buyer benefits from a gift of equity, but there are conditions that must be met and possible tax repercussions that both parties should be aware of.

What Is A Gift Of Equity?

When someone sells property to a relative or close friend for less than the current market value, they are making a gift of equity. The gift of equity is represented by the difference between the two prices.

Typically, the gift of equity replaces the home buyer’s down payment. By increasing the value of their home, it makes it simpler for them to obtain a mortgage.

When a family member sells a home, a gift of equity is frequently used. For instance, when selling the family home to their child, the parents might use a gift of equity.

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How Does A Gift Of Equity Work?

The homeowner sells the house to the buyer for less than market value when parties intend to use a financial gift of equity. No money changes hands between the two parties. Instead, the gift increases the buyer’s equity in the property. Then, instead of having to make a cash down payment when applying for a mortgage, that equity is used as the buyer’s down payment. Gifts of equity can also be used for closing costs.

Gift Of Equity Example

Consider a retired couple who sold their family home to their son and his new wife in order to downsize. The house is worth $200,000, but the parents want to pay the son’s 20% down payment. They would simply sell the house to their son for $40,000 less than its market value rather than writing him a check for $40,000.

The $40,000 discrepancy represents the gift of equity and represents the 20% down payment for the son. Since the son will own 20% of the property, obtaining a mortgage should be simpler for him. Additionally, he won’t have to pay private mortgage insurance, which is frequently necessary for down payments of less than 20%.

This real-world illustration demonstrates how a gift of equity can help buyers become more capable of becoming homeowners. When looking for a home, having your down payment made from a gift of equity can increase your options and your ability to spend more.

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To complete a gift of equity, the parties must adhere to a few specific conditions. If homeowners are thinking about using this method to sell a house to a relative or friend, they should bear these things in mind.

Including the appraised value and the sale price, a gift letter compiles all relevant information about the gift. Both the buyer and seller must sign the letter. When the home is closed, a second letter will be included with other official documents.

A certified appraisal must be performed by the home’s seller in order to complete a gift of equity. The parties can calculate the sale price and the gift of equity using the appraisal. This appraisal is required by the lender, and the gift letter will include the appraisal’s value.

The Pros And Cons Of A Gift Of Equity

Avoid paying real estate agent commissions: Because a gift of equity often happens between two family members, these home sales often don’t require a real estate agent or an agent’s commission. This benefits the seller, who typically pays commission for both agents.

Lower or no down payment for recipient: Because the gift of equity serves as the down payment, the buyer often doesn’t have to put down any additional money.

Faster home sale: A gift of equity can help to expedite a home sale. First, the buyer doesn’t need time to save a down payment and may have an easier time qualifying for a mortgage. And because the sale occurs between family members, the home buying process can go more smoothly.

Potentially avoid paying private mortgage insurance: Buyers typically must pay private mortgage insurance (PMI) when they purchase a home with less than 20% down. Because the gift of equity often serves as the down payment, it can negate the need for PMI.

Keeping a home within the family: For many people, their family home is an important memento. A gift of equity can help to keep a home within the family even when the buyer may not be able to save enough for a down payment.

Cons Of A Gift Of Equity

Legal fees for both parties: A gift of equity requires a contract between the two parties. As a result, one or both parties may have fees to an attorney to draft the contract.

Potential trigger of the gift tax: The IRS requires that people file a gift tax return when they transfer more than $15,000 in gifts to another individual. If the gift equity equals more than $15,000, then a seller would have to file this return.

Negative effect on home’s cost basis: When you sell a home for more than you bought it for, you may be subject to capital gains taxes on the profit. Because a gift of equity reduces the sale price of a home (aka the cost basis), it increases the chances that the buyer will end up paying those capital gains taxes.

Negative effect on local real estate market: A gift of equity reduces the sale price of a home. Doing so could impact the neighborhood’s real estate market because there’s a record of a property being sold below market value.

One method for selling a family home to a relative for less than its market value is to give them a gift of equity. It is simpler for the buyer to purchase the home because the lower sale price serves as their down payment. Home buyers who receive a gift of equity may be able to forego private mortgage insurance and reduce their monthly payments. Additionally, a gift of equity may enable a buyer to buy a home without having to put aside money for a down payment. Make sure to research the various financial gift types and their restrictions.

Whether you have a gift of equity or not, if you’re ready to start the home buying process, get approved right away. Call (833) 230-4553 to speak with one of our Home Loan Experts.

See What You Qualify For

Your Credit Profile Excellent 720+ Good 660-719 Avg. 620-659 Below Avg. 580-619 Poor ≤ 579.

When do you intend to sign a purchase agreement? Offer pending/found a house? Buying in 30 days? Buying in 2 to 3 months? Buying in 4 to 5 months? Buying in 6+ months? Researching options?

Do you have a second mortgage?

Are you a first time homebuyer?

Congratulations! You are qualified to continue your home loan application with Rocket Mortgage online based on the information you have provided.

If a sign-in page does not automatically pop up in a new tab, click here

Victoria Araj has worked for Rocket Mortgage for more than 15 years and has held positions in mortgage banking, public relations, and other areas. She graduated from Michigan State University with a bachelor’s in journalism with a political science emphasis and the University of Michigan with a master’s in public administration.

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FAQ

How much can you gift on a conventional loan?

According to the IRS gift tax exclusions for 2022, any down payment gift that is less than $16,000 does not need to be reported to the IRS. If the amount is higher, the donor’s gift tax return must be filled out.

Are gifts allowed on conventional loans?

Using your gift money with a conventional loan The majority of conventional mortgage loans permit homebuyers to use their down payment and closing costs in the form of gifts from acceptable sources, such as family members.

Is a gift of equity a good idea?

It can eliminate the need for PMI because the gift of equity frequently serves as the down payment. preserving a family home: For many people, their family home is a priceless keepsake. Even if the buyer is unable to save enough money for a down payment, a gift of equity can help a home stay in the family.

Who is an acceptable gift donor for conventional loan?

Acceptable Donors are those who are related to the borrower by blood, marriage, adoption, or legal guardianship, which is defined as the borrower’s spouse, child, or other dependent; or