What is a Gift of Equity?
Short answer:
A way to purchase a relative's or close friend's house with little to no down payment. The gift represents a portion of the seller’s (relative or close friend) equity in the property and is transferred to the buyer as a credit in the transaction. The Gift of Equity can be used for down payment and closing costs. Typically, a Gift of Equity can only be completed on houses that will be your primary residence or second home.
Longer answer:
One day you get a call, it's your grandparents. They want to discuss something with you and ask you to come over to their house. On your way over, you wonder what they could want to discuss. Your mind is going all over the place.
Once you arrive, your grandparents tell you, that they are thinking of selling their house to buy a smaller place with one-floor living. Before they put the house on the market, they want to know if you would like to buy the house. They will sell to you for a discount, as they only want to net a certain amount of money.
You are excited by this offer. You have been wanting to buy a home, but hear the market is scary for first-time homebuyers. Is this the right time? Do you have enough saved for a down payment? Can I afford this?
While all these questions are swirling in your head, your grandparents offer to give you a "gift of equity" to help with the down payment.
What is a Gift of Equity?
A gift of equity occurs when a homeowner sells their property to a family member and decides to forgo a portion of the sales proceeds.
For example, your Grandparents own a home worth $500,000 but only want to net $250,000 from the sale. They could sell the house to you for $250,000 and you could come to the table with a down payment and closing costs. OR they could sell the house to you for $500,000 and gift you $250,000 of equity towards down payment and closing costs.
This gift can be used by the buyer as a down payment and closing costs, reducing the amount of money they need to borrow and making it easier to qualify for a mortgage.
How Does It Work?
- Appraisal: The first step is to get the home appraised to determine its current market value. This ensures that both parties have a clear understanding of the property's worth.
- Sale Agreement: The seller and buyer agree on a sale price and the amount of money the seller wants to walk away with.
- Gift Letter: The seller provides a gift letter to the lender, stating that the equity is a gift and not a loan. This letter must include the amount of the gift, the relationship between the buyer and seller, and a statement that no repayment is expected.
- Loan Approval: The lender reviews the gift letter and other financial documents to approve the mortgage. The gift of equity is applied as the buyer's down payment and possible closing costs, reducing the loan amount needed.
Who can give you a Gift of Equity?
The following people, estates of people, or trusts of people may grant a Gift of Equity:
- The Borrower's spouse, child or dependent
- An individual related to the Borrower by blood, marriage, or adoption
- A guardian of the Borrower
- A person for whom the Borrower is a guardian
- The Borrower's fiancée or fiancé
- The Borrower's domestic partner
- An unrelated individual with close, family-like ties to the Borrower
Gift of Equity Pros and Cons
Gift of Equity Pros
- Reduced Down Payment: One of the most significant barriers to homeownership is saving for a down payment. A gift of equity can cover this cost, making it easier for the buyer to purchase the home.
- Lower Loan Amount: Since the buyer is purchasing the home at a reduced price, they need to borrow less money. This can result in lower monthly mortgage payments and less interest paid over the life of the loan.
- Family Support: A gift of equity allows families to support each other in a meaningful way. It can be a way for parents to help their children get started in life or for siblings to assist each other.
- Potential Tax Benefits: While the gift of equity is subject to gift tax rules, there are annual exclusions and lifetime exemptions that can minimize or eliminate the tax liability. It's essential to consult with a tax professional to understand the implications fully.
Gift of Equity Cons
- Capital Gains for Seller: Selling the house for a higher sales price might result in triggering Capital Gain taxes from the transaction. Sellers need to reach out to their Certified Financial Planner or Tax Advisor to learn about the possible consequences of this decision.
- Impact on Seller's Finances: The seller must be in a financial position to offer a gift of equity. Selling a home below market value means they will receive less money from the sale, which could impact their financial plans.
- Loan Approval: Not all lenders accept gifts of equity, and those that do may have specific requirements. It's essential to work with a lender experienced in handling these transactions.
Conclusion
The gift of equity is a powerful tool that can make homeownership more accessible for loved ones. By understanding the process and working with knowledgeable professionals, both the buyer and seller can benefit from this generous arrangement. Whether you're looking to help a family member or a close friend, a gift of equity can be a life-changing gesture that opens the door to new opportunities and financial stability.
If you're considering a gift of equity, reach out to a mortgage professional to explore your options and ensure a smooth transaction. With the right guidance, you can turn the dream of homeownership into a reality for someone you care about.
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These blogs are for informational purposes only. Make sure you understand the features associated with the loan program you choose, and that it meets your unique financial needs. Subject to Debt-to-Income and Underwriting requirements. This is not a credit decision or a commitment to lend. Eligibility is subject to completion of an application and verification of home ownership, occupancy, title, income, employment, credit, home value, collateral, and underwriting requirements. Not all programs are available in all areas. Offers may vary and are subject to change at any time without notice. Should you have any questions about the information provided, please contact me.
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