You’ve been doing the math for months, and you know you can afford the mortgage for the home you want to buy. Problem is, how will you come up with that 10 percent down payment?
Suddenly, Grandpa says he’ll chip in the extra $7,000 you need, no strings attached.
Grandpa wants to give, and you want to take. It’s all very simple and now you can have that house, right? Well, maybe you can have the house, but receiving a down payment gift is not as simple as unwrapping a package and donning a new sweater or bracelet. The giver, too, must follow certain rules.
Like an Emily Post with clout, lenders and the IRS have rules to follow about giving and receiving. If you don’t, you’re not just breaking arcane rules of etiquette, you could end up not getting your mortgage and the giver could owe taxes.
Today, many home buyers depend on gifts, and lenders are not at all unfamiliar with the procedures. In fact, says Christopher Mayer, an economist with the Federal Reserve Bank of Boston, some 24 percent of all first-time home buyers received a gift last year, and that gift averaged about 55 percent of the down payment amount.
Realizing that many buyers, especially first-timers, can’t get into the housing market without help, the secondary mortgage market-which sets lending guidelines-has relaxed its rules somewhat over the last few years, Mayer says. What’s more, some mortgage lending firms have introduced special programs for buyers receiving gifts.
So whether you plan to give or receive, here are the guidelines.
Size counts
Many lenders will allow the entire amount of the down payment to be a gift-as long as the down payment is 20 percent or more of the purchase price of the home, says James Morley, assistant vice president of WestAmerica Mortgage Co., Chicago.
But if a gift comprises less than that 20 percent, lenders generally expect the buyer to be putting up 5 percent of the purchase price with his or her own funds, Morley says. That means, for instance, if the home buyer wants a house priced at $100,000, and he’s getting a gift of $5,000, the buyer himself must put up at least 5 percent, or $5,000.
However, there are special lending programs where gift rules are more relaxed. A mortgage insured by the Federal Housing Administration (FHA), for instance, allows all of the down payment and closing costs to be a gift, Morley says. (FHA mortgages, though, cannot amount to more than $151,725 in the Chicago area.)
A special program sponsored by the Federal National Mortgage Association (Fannie Mae), known as Community Home Buyer’s, allows a borrower to put up 3 percent of the purchase price with his or her own money, and get another 2 percent from a gift. Borrowers qualify if they are at or below the median income level in their area-$51,300 for a family of four in the Chicago region.
Taxing matters
The size of gift for the down payment is also significant from the giver’s perspective. You can give up to $10,000 per year per person to as many people as you want without paying any federal gift taxes or filing any IRS forms.
Accountant Gerry McCullough of GLM Financial Group in Barrington gives this example: A married couple can each give $10,000 to their son and daughter-in-law, for a total of $40,000, without worrying about the IRS.
If you give more than the $10,000 per year limit, the rules get a little more complicated. You have to file a separate gift tax return when you file your income tax return, McCullough says. But you don’t have to pay any taxes on the amount you gave over $10,000, he says, unless the amount puts you over the lifetime bequest allowance of $600,000.
The reason the lifetime allowance is $600,000, McCullough says, is that is the amount below which your heirs can inherit your estate without paying taxes. If you wish, you can give your funds away while you’re alive without paying taxes, as long as you don’t give in excess of $600,000.
Blood ties
Generally, says Scott Schmitt, director of housing impact for the Chicago office of Fannie Mae, which is the largest secondary market firm and sets policies for lenders, lenders like to see a gift coming from a relative. “Lenders want to see a true gift. If people other than relatives are giving, the likelihood is that there may be an intent on the part of the giver to be repaid,” he explains.
In fact, notes Dru Bergman, executive director of the DuPage Homeownership Center, if a relative has been living with you for a year, and will be living in the new home, 100 percent of the down payment can come as a gift from that blood boarder.
Although relatives are favored, “there are certainly exceptions” to that dictum, Schmitt says. Especially under the Community Home Buyer’s program, gifts from friends, churches and non-profit organizations are sometimes allowed.
Glendale Heights residents Arnold and Sue Young secured gifts from two sources-a friend and a relative-when they recently bought a home. Like many first-time buyers, the gifts were the necessary ingredient to make homeownership a reality. “On one income, and with five kids, owning a home looked like an impossible dream,” Young says.
Spirit of giving
It’s important that a gift be just that, because lenders don’t want borrowers to be encumbered with another debt to be repaid, Schmitt notes.
Additionally, lenders will require that donors submit a gift letter, spelling out in black and white that they don’t expect repayment. Lenders also want the assurance that the donor didn’t borrow the money. Gift-givers have to offer proof, through bank statements and the like, that they have owned the funds that they are now relinquishing.
“We’ll look back several months at bank statements,” says John Ratkovich, lending officer with American Home Finance, Palatine. If a donor’s bank account suddenly swells, “we’ll wonder,” he says.
Nancy Manisco, broker/owner at ERA Wynway in Des Plaines, knows how strict lenders can be about documenting gifts. “I had a closing once where the gift letter was for $50,000, but the buyer didn’t need that much, and didn’t want to take that much,” she recalls. “The buyer took only $35,000, but didn’t tell the bank about the change. When the closing came, the gift letter said $50,000, and the donor had transferred just $35,000 into the buyer’s account. The closing couldn’t proceed until a new gift letter was drawn up.”
All of these financial revelations can be a bit uncomfortable for relatives, such as parents and children. “Sometimes parents don’t like their children to see their assets,” notes Tabetha Roman, loan officer with Columbia National Bank, Chicago. “But they don’t have to see everything. Parents just need to show a withdrawal and then the money going into the child’s account.”
The gift letter is crucial to a lender, explains Lake Zurich real estate attorney Neil Anderson, because it eliminates any possible claim the donor has on the home. If the borrower doesn’t keep up his mortgage payments, the lender is free to foreclose on the property without paying off the gift-giver.
But Anderson says he has seen many borrowers and gift-givers comply with the formalities, but make different arrangements on their own later. “I’ve seen a father give a son $10,000 toward a down payment, and then after the closing, the son bought Dad’s motorcycle for $10,000 paid over the next 10 years.” Lenders don’t really care about such agreements, says Anderson, because they have nothing to interfere with their right to foreclose if necessary.
Sometimes, gift-givers don’t bestow dollars, but rather their good credit history. Borrowers who exceed the standard lending ratio that requires that no more than 36 percent of monthly gross income be encumbered by mortgage payments and other regular debt, may need someone to “co-sign” before they can qualify for a mortgage.
Co-signing means that someone with a good credit record and the ability to take up the mortgage payments guarantees the loan payments will be made if the buyer misses payments, says Ratkovich of American Home Finance. The co-signer is on the title and the mortgage documents, and cannot be removed until the borrower refinances, says Ratkovich.
“Co-signing isn’t done as much as gifting money,” says real estate broker Manisco. “The person who co-signs also has to qualify for the mortgage under the 36 percent ratio rule. If the person who co-signs later wants to buy property . . . he may not qualify, because of the extra debt on his record.”
