What Is A Gift Letter And How Do You Use It To Get A Mortgage?
Rachel Burris6-Minute Read
September 29, 2020
It’s no secret that purchasing a home is an expensive undertaking. Even if you plan to obtain a mortgage, you still need to be able to afford the down payment. While you may not have 3 – 20% of the purchase price in your bank account, you may have a family member who’s willing to gift you the funds. If you do, you’re going to need a gift letter for your mortgage.
What Is A Gift Letter?
A gift letter for a mortgage is written proof that cash has been given to a borrower as a gift with no expectation of repayment. It provides necessary information for lenders and their regulators that establish where the funds came from and the conditions under which they were given.
Your lender will require an explanation for any large cash deposits made during or in anticipation of the loan application process. Therefore, if you’ve received a cash gift or plan to, it’s essential that you’re prepared to give your lender a gift letter that discloses the source of these new funds.
What Does A Gift Letter Contain?
Typically, lenders provide a standard form to loan applicants who plan to use a gift to pay for the down payment on a house. The standard gift letter contains the following information:
- Donor Information:
- Donor’s name, address and phone number
- Donor’s relationship to the borrower
- Borrower Information:
- Borrower’s name
- Address of the property the borrower will be purchasing
- Gift Information:
- Dollar amount of the gift
- Date the funds were or will be transferred to the borrower
- Intended use of the gift
- Donor’s signed statement that no repayment is expected
- Borrower’s signature
Gift Letter Template
Instead of having your donor write their own gift letter, you can provide them with the following template.
Who Can Donate? Rules By Mortgage Type
Unfortunately, you can’t receive a cash gift from just anyone. There are specific rules regarding who your donor can be, and those rules differ by mortgage type.
Since conventional loans are backed by the government, Fannie Mae and Freddie Mac determine the rules regarding who can donate gifts for this type of mortgage. Their regulations stipulate that gifts must be made by a family member. Acceptable familiar relationships include:
- Spouse (including domestic partner and fiancé(e))
- In-laws (Fannie Mae will also accept future in-laws)
Family members that fall into the following categories may also be permitted: step, foster, great or adopted relatives.
When obtaining an FHA loan, the borrower may use gifts from family members and other specific categories of individuals who have demonstrated a clear interest in the borrower’s life. Although most family members qualify as acceptable donors, you’ll notice that cousins, nieces and nephews may only be eligible if they display a clear interest in the borrower. Permitted donors include:
- Family members:
- Spouse (including domestic partner)
- Parent (including step and foster)
- Grandparent (including step and foster)
- Sibling (including step and foster)
- In-laws (including mother, father, daughter, son, sister and brother)
- Child (including step, foster and adopted)
- Grandchild (including great and step)
- Other invested individuals:
- Borrower’s employer
- Borrower’s labor union
- Government agency or public entity that provides financial assistance to first-time home buyers
- Charitable organization that provides financial assistance
- Close friend with a clearly defined interest in the borrower (including ex-spouses and extended family, such as a cousin, niece/nephew, foster sibling)
VA And USDA Loans
VA and USDA loans are the least restrictive when it comes to who can donate cash gifts to borrowers. Instead of having a list of acceptable donors, these entities merely restrict gifts from the following types of individuals:
- The seller of the subject property
- The builder or contractor of the subject property
- The developer of the subject property
- The buyer’s agent or listing agent of the subject property
How Can The Money Be Used? Rules By Property Type
Believe it or not, there are also rules regarding how you can use cash gifts. These rules differ depending on the type of property you are purchasing.
If you’re purchasing a primary residence, you can use a cash gift to pay for your down payment. However, there are certain stipulations to this rule:
- For single-family units: The gift can finance 100% of your down payment.
- For multi-family units: The gift can finance 100% of your down payment, assuming you put at least 20% down. If you plan to make a down payment of less than 20%, you must contribute at least 5% of the funds yourself.
If you’re purchasing a second home, you can use a gift to fund your down payment only if you plan to obtain a conventional loan. You will not be able to get an FHA, VA or USDA loan.
Unlike with primary residences, you may not use a cash gift to purchase a multi-family unit. Furthermore, when using a gift to buy a single-family, second home, you must contribute at least 5% of the down payment if you intend to put less than 20% down.
If you’re planning to purchase an investment property, you may not use any gift funds.
Gift Letter FAQs
The regulations gift letters and funds can be somewhat confusing. To give you a deeper understanding of the rules and reasons behind them, let’s take a look at some commonly asked questions.
Why Do Lenders Care If I Received A Gift?
The reason lenders care if you’ve received a gift is that it impacts their assessment of how risky it is to lend you funds. Remember, lenders won’t approve you for a mortgage unless they feel confident that you’ll be able to pay back the funds borrowed with interest.
A large cash gift can be viewed as a red flag, especially if there’s concern that the gift funds do not meet regulations. The primary concern for lenders is that the gift may actually be an informal loan that the donor expects to be paid back.
If the gift is actually a loan in disguise, you may have more debts than you can realistically pay off. Therefore, your lender must know if you’ve been given any additional funds that are expected to be repaid, as those debts will impact your debt-to-income ratio (DTI) – and thus, your mortgage approval.
How Do Lenders Know If I Received A Gift?
Even if you don’t immediately report them, lenders can typically tell if you’ve received gift funds. The reason lenders are able to discover gifts received is that your finances go through extensive examination in the underwriting stage of your mortgage application.
During the application process, a mortgage underwriter analyzes your finances, which involves reviewing your bank statements. All atypical deposits are scrutinized during this process, and the underwriter notes any money that inexplicably enters your accounts. Since large gifts are atypical, they’re immediately reported.
How Much Of A Gift Requires A Gift Letter?
Now, keep in mind that your lender won’t expect you to have a gift letter for small amounts of cash you’ve received. For example, you won’t need to worry about a $50 check you got for your birthday.
However, lenders will be looking for an explanation for any gift that is greater than half the value of your total monthly household income. So, if you make $2,600 a month and your partner makes $2,400, your total monthly household income would be $5,000. Therefore, you would need a gift letter to report any gift of $2,500 or more.
Will Receiving A Gift Hurt My Chances Of Getting A Mortgage?
You don’t have to worry about being penalized for receiving gift funds. As long as the gift adheres to the rules listed above, and you provide a gift letter to disclose it, receiving funds to help you pay for your down payment won’t hurt your chances of getting a mortgage.
Summary: Gift Letters Are Part Of The Mortgage Application Process
While you may not have the savings for a down payment right now, that doesn’t necessarily mean you can’t purchase a home. Many home buyers have found it possible to make their dreams of homeownership a reality thanks to the generosity of family members.
However, if you receive a gift to help you buy a home, make sure you report it through a gift letter. The easiest way to do so is to fill out the gift letter template included in this article. If you have any questions, be sure to ask your mortgage lender. They’ll be happy to help you through the process.
If you want to learn more about becoming a homeowner, read about the home buying process.
Get the right home loan for you.
Short Sale: What It Is And How To Complete One To Purchase Real Estate
Short sales allow financially distressed homeowners to avoid foreclosure by selling their home for less than what they owe. Find out how short sales work.
Things Your Parents Didn’t Tell You About Living On Your Own
If you’re living alone for the first time), fear not. Everyone figures it out eventually, and we’ve got some tips that will help ease the transition.