Leveraging the Gift of Equity for Your Conventional Home Loan

Buying a home is an exciting milestone, but saving up for the down payment can be a major challenge, especially for first-time homebuyers. This is where a gift of equity can make all the difference in turning your dream into reality.

What is a Gift of Equity?

A gift of equity refers to when the seller of a home gifts a portion of their equity in the property to the buyer. This effectively lowers the purchase price and allows the buyer to get into the home with less money out of pocket.

The gift is transferred to the buyer as a credit at closing. For example, if a home is worth $300,000 and the seller has $100,000 in equity, they can choose to gift some or all of that equity to the buyer. If they gift $20,000, the sales price becomes $280,000 and the buyer’s down payment is now based on that lower amount.

How Does It Work for Conventional Loans?

Fannie Mae guidelines allow gifts of equity to be used with conventional loans secured by primary residences and second homes. The gift can go towards the down payment, closing costs, and prepaid items.

Here are some key considerations

• The acceptable donor requirements for personal gift funds also apply to gifts of equity. Most commonly, funds are gifted by relatives but can also come from non-relatives or entities.

• When structuring the gift, the donor cannot remain on title after closing.

• The recipient must make at least a 5% down payment from their own funds even when receiving a gift of equity.

• Gifts of equity from immediate family members are not subject to interested party contribution limits that normally apply to seller contributions.

• The amount gifted must be listed on the settlement statement provided to the lender.

• A gift letter must be signed by the donor stating the gift does not need to be repaid.

• The gifted funds cannot count towards any reserve requirements.

As you can see, even though the gift comes from the seller, it can provide the same benefits as getting gifted funds from a relative. This creative solution expands your options as a buyer.

Tax and Legal Implications

From a tax perspective, the donor will not owe gift tax on the gift of equity as long as it is within their lifetime exemption amount ($12.92 million in 2023). However, they may owe capital gains tax on the difference between original purchase price and gifted sale price.

It is a good idea for both parties to consult with professionals to understand tax and legal implications before moving forward. Here are some key considerations:

For the Seller:

• Consult an accountant or tax advisor to determine capital gains owed based on the amount of equity gifted.

• Review sale contract with real estate attorney to ensure proper documentation of the gift of equity.

For the Buyer:

• Confirm with lender that documentation will satisfy loan requirements.

• Consult own accountant or tax advisor on any implications to the buyer’s taxes.

• Review home purchase documents with real estate attorney or trusted advisor.

While there are details to get right, the gift of equity can be handled smoothly when parties get informed and obtain necessary professional guidance.

Finding Sellers Willing to Gift Equity

As a buyer, your real estate agent is key to finding sellers motivated to gift equity. Here are some tips for them to locate potential sellers:

• Target listings well below market value as the seller may be willing to negotiate further with a gift.

• Consider estate sales where inheriting relatives are motivated to sell quickly under fair market value.

• Ask sellers directly if they would consider gifting equity, especially on homes that have been listed for an extended time.

• Some investors may be willing to gift equity on rental properties if they desire a smooth sale.

• For certain hard-to-sell properties, negotiate a deal with the seller’s agent to have the seller contribute equity.

• Research divorce listings since one party may agree to gift equity to facilitate the property sale and resolution of marital assets.

• Keep an eye out for short sales where the lender accepts less than is owed, allowing the seller to possibly gift the difference.

With some creative thinking and persistence, there are often mutually beneficial deals to be struck between buyers and sellers. Your agent plays a pivotal role in seeking out opportunities and negotiating the gift of equity.

Benefits for Home Buyers

For buyers lacking funds for a down payment or closing costs, a gift of equity can provide that missing piece to get into homeownership. Here are some of the top benefits:

Lower Down Payment and Closing Costs

The gifted equity goes directly towards lowering your required down payment and closing costs. If you can now qualify for a lower down payment loan program, your upfront cash needed could be reduced dramatically.

Less Needed for Down Payment Assistance Programs

Many down payment assistance programs require you to contribute a minimum amount from your own funds. With a gift of equity, you may now have the ability to provide that minimum without assistance or be able to reduce the amount of assistance needed.

Possibility to Avoid Mortgage Insurance

Since the gift is lowering your loan-to-value ratio, you may now be able to get below 80% LTV and avoid private mortgage insurance (PMI). The reduction in monthly payment can be significant.

Opportunity to Buy Sooner

For those struggling to save up adequate funds for a down payment, a gift of equity can shave years off your timeline. You may be able to buy that home now rather than years down the road.

Ability to Purchase More Home

With gifted equity, you can qualify for a higher mortgage loan amount and increase your buying power. This allows you to purchase a more expensive home than you could otherwise afford.

Improve Debt-to-Income Ratio

By reducing the mortgage loan amount needed, the gift of equity also lowers your monthly mortgage payment. This may help you meet debt-to-income guidelines and qualify for the home you want.

As you can see, the advantages are substantial. A gift of equity can be life-changing and propel you towards reaching your homeownership goals sooner.

Benefits for Home Sellers

Sellers also stand to gain from gifting equity. Here are some of the main incentives:

Receive a Competitive Offer

In a bidding war scenario, you can give yourself an edge over cash offers by gifting equity to motivate the seller to accept your terms. This becomes your negotiating tool to beat out other buyers.

Contribution Still Less Than Closing Costs

Some sellers are already planning to contribute 3% or more towards a buyer’s closing costs as an incentive. Gifting equity may actually cost them less out of pocket than paying those closing expenses.

Quicker Sale

Offering a gift of equity, especially a substantial amount, can motivate buyers and accelerate an offer. This allows you to complete the sale faster.

Higher Net Proceeds

Gifting equity rather than lowering the sales price can result in more net proceeds to the seller. If the home appraises for higher, the seller still receives the appraised value. With a reduced sales price, the seller would net less.

Tax Benefits

Gifting equity allows the seller to avoid lowering the sales price which would increase capital gains owed. It can also keep them under gift tax limits. Consult a tax professional to understand your specific situation.

Goodwill Gesture

Some sellers may be willing to gift equity to help a buyer get into their first home or dream home. It can feel good to give the gift of homeownership.

Emotional Motivations

In certain cases, emotions may drive the gift of equity. For instance, helping relatives, friends, or even a tenant buy the home could provide fulfillment.

Creative Solution for Unique Situations

When facing unique scenarios like a divorce or distress sale, gifting equity can help resolve the situation in a mutually beneficial manner. The seller sees value in the smooth transaction.

There are clearly incentives on both sides of the equation when it comes to gifting home equity. Sellers gain tangible benefits while also feeling good about helping someone buy their property.

Navigating the Gift of Equity Process

Executing a mortgage transaction with a gift of equity requires some careful coordination between parties. Here is an overview of the process:

1. Seller Decides Equity Amount to Gift

The seller will determine how much equity they are comfortable gifting based on their specific motivations and financial situation. Their agent can help assess implications.

2. Buyer Confirms Impact on Loan Amount

Before making an offer, the buyer will verify with their lender by how much a gift of equity would reduce the loan amount needed. This will impact affordability.

3. Buyer Submits Offer with Gift of Equity

The buyer makes an offer at appraised value or sale price minus the gifted equity. The contract states seller will contribute a gift of equity of $X towards purchase.

4. Seller Accepts and Contract is Finalized

Presuming the seller accepts the contract terms, the transaction proceeds as normal except for the gift of equity language.

5. Lender Confirms Acceptable Documentation

The lender verifies the gift letter and any other