Down payments often serve as a hurdle to many home ownership goals. A recent study conducted by the Association of Realtors’ showed that the third biggest hurdle potential homeowners are scared of is the down payment. Luckily, there are loans available that offer 100% financing with NO down payment.
USDA home loans and VA loans are two types of loan programs that require ZERO down payment. In fact, even FHA loans could cost you nothing out of pocket. FHA and some other mortgage programs allow you to use gift money for the down payment.
Using gift funds for a down payment is allowed for some loan programs as a way to increase the amount of mortgages offered. You will need to provide a gift letter to the lender to be able to use gift funds.
When a down payment gift is allowed
Donations of down payments can be applied to mortgages on your primary and second homes. Mortgages on investment property do not qualify for acceptance of gifts for down payments. For any Government or Private loan that allows the down payment to be a gift from a friend or family member.
Loan Types that Allow Down Payment Gifts
Getting an FHA Loan with NO downpayment
Generally, lenders require that the donor have a familial or marital relationship with the prospective borrower. Depending on the loan, the following normally serve as acceptable sources of gifts for borrowers:
- Fiance or domestic partners
- Child or dependent
- Uncle, aunt or other person related by blood or marriage
- Legal guardian
For loans backed by FHA, a “close friend” who documents his or her “clearly defined” interest in the transaction will suffice. Depending on the lender, “close friends” don’t qualify as donors for conventional mortgages.
Gift Letter for Mortgage
Your lender will likely require a “gift letter for mortgage” signed by the donor. This constitutes one way your bank or mortgage company verifies that you’re receiving a gift, not incurring debt. The gift letter should contain:
- The name, address and telephone number of the donor
- The donor’s relationship to you
- The dollar amount of the gift
- The date of transfer of the funds for the gift
- State that the donor does not expect repayment from you
- Street address of the property being purchased
Download this gift letter for a mortgage here. You can fill this letter out and submit it to your mortgage lender.
The Amount of the Gift
For a Federal Housing Administration (FHA) borrowers generally can make the down payment entirely from donated funds. However, if your credit score falls between 580 and 619, at least 3.5 percent of the purchase price must come from your own money as opposed to the donor’s funds.
If you’re pursuing a conventional loan, you can make the down payment totally from the gift if you put down at least 20 percent of the purchase price.
For loans that equal more than 80 percent of the purchase price, the type of mortgage will determine what must come from your own money. On loans backed by FannieMae or FreddieMac, you can rely completely on gifted funds if you’re buying a single-family residence. You must contribute at least five percent from your own money if you’re borrowing for a two-to-four unit principal residence or a second home.
Some conventional lenders may require you to include some of your own money with the gift for the down payment any time your loan-to-value ratio exceeds 80 percent. Check with your lender for its specific requirements in such a situation.
Assistance from Labor Unions and Other Organizations
Borrowers of FHA-backed loans can obtain gifts of equity via their labor unions or employers or from charitable organizations.
Gifts from charitable organizations are permitted on FHA loans if the organization held tax-exempt status on or before the date of the purchase contract. To determine if your charitable donor is tax-exempt, go to the Internal Revenue Service’s “Exempt Organizations Select Check Tool.”
FHA also accepts down payment assistance, such as grants, furnished by governmental agencies that serve low or moderate-income borrowers or first-time home buyers.
Donor With an Interest
In a FHA and conventional loan, your donor cannot have a financial interest in you getting the loan. Thus, the following people are typically prohibited from gifting you the down payment:
- Real estate agent or broker
- Builder or contractor
- Anyone affiliated with these parties
FHA treats a “gift” from an interested party as an inducement for you to purchase the property. As a result, these “gifts” must be subtracted from the purchase price.
Proof of Donation vs. Loan
Your lender or the FHA will require you to prove that the donor does not expect payment in return for the “gift.”
The distinction between loan and gift is essential to a lender’s decision to approve a loan. Lenders underwrite loans based on your credit score, assets and ability to pay. In particular, your debt-to-income ratio generally should not exceed 36 percent. With some exceptions, federal guidelines cap the ratio at 43 percent.
If the “gift” is actually a loan, you will be denied the mortgage because of a lack of down payment funds. If you’re required to pay back any portion of the gifted down payment it’s considered a loan.
Documenting the Withdrawal
In addition to the gift letter, you need proof that the money came from the donor or donor’s account. This involves, depending on how the donor paid, a copy of the cancelled personal check, cancelled certified check, money order, withdrawal slip from the donor’s bank account. Also, ask your donor to have a copy of his or her bank statement showing the withdrawal of the money.
More on Employer Assistance
FannieMae permits your employer, including a credit union affiliated with your employer, to loan you money for a down payment under certain circumstances:
- A direct loan which you payback in full, either as a second mortgage or unsecured loan
- A second mortgage or unsecured loan, either of which can be forgiven
- A second mortgage or unsecured loan in which your obligation to repay is deferred, or delayed
If the employer grants you a second mortgage and requires regular payment each month, that monthly payment is figured into your debt-to-income ratio. A second loan for the downpayment is usually for 80/10/10 piggyback mortgage loans.
Paying Off Other Debt
For FHA loans, unless it is a family member, donors, including nonprofit organizations, cannot payoff installment loans, credit card debt, accounts in collections, judgments or liens.
FHA does not treat payment of consumer debts by non-family members as acceptable down payment assistance. Instead, such payoffs of consumer debt constitute an inducement to purchase and trigger a dollar-for-dollar reduction of the purchase price.
Gift of Equity
A gift of equity may be allowed by your lender for conventional loans. The seller reduces the purchase price by some of the seller’s equity in the home. These credits are allowed on the purchase of the main home and a second home.
FHA does not permit equity credits from the seller, as these are deemed inducements to the borrower. An equity credit will lead to FHA reducing the purchase price.
If you enlist down payment assistance, make sure you understand the obligations imposed on your donor and you. Contact your lender to learn the specific rules for accepting and documenting a gift of mortgage or other down payment assistance.
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Randall has over 15 years of experience in the mortgage and credit industries. He spends a chunk of time helping consumers understand their credit, advise them on how to increase their credit, and lending his mortgage expertise to help them find the right type of loan. Randall lives in Dallas, Texas with his two sons.