Often times when gifts from family members are involved, borrowers my opt to use FHA financing since the guidelines are (currently) more flexible than conventional with regards to gifts. With FHA, a gift from a family member can go towards to borrowers minimum required investment with conventional financing, it cannot.
Here’s an example. Let’s say we have a sales price of $265,000 with 10% down payment creating a loan amount of $238,500. Once you factor in estimated closing costs of $2,400 and and prepaids/reserves of $3,100; the amount due at closing is roughly $32,000 (10% down = $26,500 + $2,400 + $3,100). The borrowers also have a $5,000 contribution towards closing costs from the seller.
At this loan to value, with conventional financing requires that the borrower invests a minimum of 5% of their own personal funds into the transaction. Unlike FHA, these funds cannot be gifted from the family members. NOTE: if the gift is 20% down or more, the 5% rule for conventional financing does not apply (the whole down payment can be gifted).
Staying with our example, this means that the borrower must contribute 5% of $265,000 of their “seasoned” funds = $13,250.
With the amount due at closing at $32,000, the borrower must contribute at least $13,250 (5% of the sales price) of their own funds towards the $32,000 (10% down payment). This leaves $18,750 remaining “due at closing”. The borrowers earnest money check (if sourced – meaning documented as being their own funds) can count towards the 5% investment requirement and so can deposits with the mortgage company. For example, the our borrowers submitted an earnest money check in the amount of $5,000 with their purchase and sales agreement, they would have $8,250 remaining to invest into the transaction of the 5% requirement ($13,250 – $5,000 = $8,250).
Once the borrower meets the 5% down payment, the gift and any seller credits can be applied towards the transaction. A seller contribution can only go towards allowable closing costs and prepaids. With this scenario, that totals $5,500 ($2,400 + $3,100). The seller cannot contribute more than $5,500 (actual closing costs and prepaids).
Unlike a seller contribution, the gift from parents can be applied towards down payment or closing costs/prepaids, once the borrower’s 5% investment is met. If your gift from the parents is larger than the remaining amount due at closing, you can either reduce your loan amount or not use the entire gift. NOTE: Your parents may want to check with tax adviser regarding possible tax implications with gifting funds.
With FHA financing, their is also a minimum required investment from the borrower, which is currently 3.5% of the sales price. A gift from parents CAN be applied towards the borrowers minimum required investment (the 3.5%).
When parents provide a gift with conventional or FHA financing, they need to be prepared to provide documentation of where the funds came from. They will sign a gift letter and provide a recent bank statement showing that the funds are available. There also needs to be a “paper trail” documenting the transfer of the gift funds (photo copy EVERYTHING–you’re better off having too much paper work to provide your mortgage originator than not enough).
If you have questions about financing a home located in Washington State, please contact me, I’m happy to help! We have both FHA and conventional programs available.
Related post: Gifts from the Bank of Mom and Dad – Part 1: FHA