How FHA Gift Funds Work
Having enough money saved to pay the down payment to buy a home isn’t easy. If you have rent to pay, putting aside enough each month to buy a home is challenging. But when you use an FHA loan to buy your home, they allow gift funds that let your relatives help you with these expenses.
If you are looking to use gift money to buy a home, there are a few things you need to know about the process before you begin.
What are FHA Gift Funds?
Created to assist buyers with moderate and lower incomes, the government-backed FHA loan program makes buying a home easier.
FHA loans allow buyers with lower credit scores to be approved when they would be denied a conventional home loan. Whether the borrower is a first-time buyer or someone carrying outstanding debts, the FHA program could make homeownership possible for buyers who would otherwise not be approved.
These buyers are also less likely to have the funds available for the down payment or closing costs, and the other expenses they will be expected to cover. To assist buyers further, the FHA allows borrowers to receive funds to help with the expenses that need to be paid when buying a home. This is allowed as gift funds that can be provided by family and some other organizations.
FHA gift funds are another way that this government-backed program helps moderate and lower-income families become homeowners. However, even though the FHA requirements are more flexible, a borrower must still meet certain criteria:
- Only a primary residence can be financed, and you need to move in within 60 days
- The home has to meet FHA’s minimum property standards ensuring the home is safe and habitable
- The value of the home has to be appraised for the sales price or more, otherwise the difference will have to be found or the price renegotiated
- Mortgage insurance premiums have to be paid by the buyer, both upfront and monthly
FHA Credit Requirements
The minimum down payment amount required with an FHA loan is 3.5% of the purchase price. But to qualify for this lower down payment, the borrower has to have a credit score of at least 580.
Borrowers can qualify for an FHA loan with a score of only 500, though a 10% down payment will be needed to be approved. While gift funds will help out many buyers, they will be particularly beneficial to buyers who need to find 10% of the purchase price for their down payment.
Even if you meet the credit score requirements, and have enough money for the down payment and other expenses with gift funds, there are other qualification requirements.
Your income and the amount of debt you have will be considered during the underwriting process. If your debt repayments take up too much of your income each month, the FHA lender won’t find you have enough income to cover the monthly mortgage payments.
Do I Need an FHA Gift Letter?
While you might imagine that a lender doesn’t care where the money comes from as long as there is enough money available, this isn’t the case. During the underwriting process, the lender will look at your finances, and anything unusual will require further investigation.
When an FHA borrower has assistance to buy with gift funds, the lender will need to know more about this unusual cash transfer. When more than 1% of the purchase price or the appraisal value, whichever is higher, is gifted, a letter is required stating that there is no expectation of the money being repaid.
Without the gift letter, the lender will assume that the gift amount is a loan that needs to be repaid and will affect the borrower’s qualification. The letter from the gift donor has to make it clear that the money isn’t a loan.
Other important information is required in the gift letter and this includes:
- The name and contact details of the gift donor
- The relationship between the borrower and the gift recipient
- The reason for the gift
- The amount of money being gifted
- The address of the property being purchased
This letter must also be signed and dated by both the gift donor and the recipient.
FHA Guidelines for Gift Funds
For a borrower to be able to use gift funds, the FHA gift fund guidelines have to be met. This means that the gift funds must come from valid sources that can be documented, as well as providing a gift letter.
In general, the FHA isn’t concerned with where the donor’s funds come from. Even borrowing money can be acceptable as long as it doesn’t require the person receiving the gift to repay the loan. The funds also cannot be provided as a result of the sale in any way. The donator can use money from savings accounts, and the sale of investments like stocks and bonds.
Lenders like to see consistent and regular cash flow entering your bank account when they underwrite the loan. However, a gift to help with your down payment and closing costs is out of the ordinary and could be an indication of problems. For this reason, the lender will want more information about the gift funds.
The lender will want to see documents that show the money being transferred from one account to the other. This can mean a statement from the gift donor’s account and one from the borrower showing the transfer. It could also mean a copy of the cashier’s check and receipt from the bank, and printouts showing the account balance before and after this happens.
If stocks or bonds are sold to provide the gift funds, similar documentation will be required. A clear paper trail makes it easier for the underwriter to confirm the source of the funds.
Receiving FHA Gift Money
When gift funds are received, the borrower should deposit those funds only after they have taken a printout of their account with the current balance. Then when the money is in their account, they need a new printout with the new balance.
If the borrower receives more than one gift, they will need to do the same thing with each and not deposit them together.
Gift Tax Limit
The gift donor also needs to be aware of the amount of the gift tax limit. This limit is $18,000 for a single person in 2024 and $36,000 for married couples. This is an annual allowance that lets you avoid filing a gift tax return.
Even if you exceed this amount and have to file a gift tax return (IRS Form 709), it probably means you still won’t pay extra tax. Federal gift tax will only have to be paid if you exceed the lifetime estate tax exemption, which is currently $13.61 million and double for married couples.
Gifts of Equity
There is another way to help a family member buy a home that doesn’t involve donating money. If a parent wants to sell their home to their adult child at a discount, the FHA allows them to gift equity in the property.
If the home is worth $350,000, a parent could sell it to their child for $250,000, giving them $100,000 of equity. The borrower could then use this equity as a down payment to help them with their loan approval.
Can Anyone Gift Funds for an FHA Loan?
The FHA does have some restrictions about who can donate money to help a borrower. Money can be gifted from the following people:
- The borrower’s relatives
- A close friend with a documented interest in the life of the borrower
- The borrower’s employer
- A labor union
- Government agencies
The FHA will also allow gifts from charitable organizations as long as they have federal tax-exemption status and meet the requirements for a charitable organization as defined by the IRS. The FHA doesn’t allow a non-profit entity to provide gifts that are used to pay off credit cards, liens, judgments, and other similar debts.
People and entities who are not acceptable donors include:
- The seller, except when they are a family member gifting equity
- The mortgage lender
- Real estate agents or brokers
- The home builder
- An associated business to the seller
The donor cannot be a person or business that has any interest in, or benefits from, the sale of the home. A gift from someone associated with the property would be considered an inducement to purchase, and the gift would have to be subtracted from the sales price.
Real Estate and mortgage expert Bill Gassett of Maximum Real Estate Exposure provided insightful advice.
“Luke, as you know, FHA loans are a fabulous mortgage product for borrowers with limited down payment funds and lower credit scores. They get many potential buyers into homes that otherwise would not be able to.
Of course, the gifting option is also excellent. Over the years, I have had a few clients who received helpful funding from their parents. It was just a little extra breathing room that made all the other expenses of buying a home a little bit more manageable.
It makes being a fiscally responsible first-time homeowner that much more straightforward. For all of these reasons, I highly recommend the FHA mortgage program.”
Summing Up FHA Mortgage: Using Gift Funds
For home buyers with less-than-perfect credit, an FHA loan can help them afford to purchase a home that might otherwise seem impossible. But even with the advantages offered by the FHA loan program, finding the money for a down payment, closing costs, and other expenses can still be a problem.
FHA gift funds allow more people to be approved and buy a home. As long as you understand there is more documentation required, the underwriting process shouldn’t hold up your purchase.
About the author: This article “How FHA Gift Funds Work” was written by Luke Skar of MadisonMortgageGuys.com. As the Social Media Strategist, his role is to provide original content for all of their social media profiles as well as generate new leads from his website.
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