S2E31 – Using Gift Funds To Buy A House

Are you a first time home buyer planning on using gift funds to buy a house in 2023? What are gift funds? What can gift funds be used on when buying a house? What loan programs allow gift funds? What is required when using gift funds to buy a house? In this episode we discuss everything you need to know about gift funds when buying a house in 2023 to become The Educated HomeBuyer.

✅ – Want to get connected with us or to a local expert in your market, please reach out at http://www.theeducatedhomebuyer.com/expert

Connect with me 👇 Jeb Smith (huntington beach Realtor/orange county real estate) DRE 01407449 Coldwell Banker Realty ➡I N S T A G R A M ➳ https://www.instagram.com/jebsmith ➡Y O U T U B E ➳https://www.youtube.com/c/JebSmith

Connect with me 👇 Josh Lewis (Huntington Beach Certified Mortgage Expert) DRE 01209148 Buywise Mortgage M:714-916-5727 E: josh@buywisemortgage.com ➡I N S T A G R A M ➳ https://www.instagram.com/borrowsmartjosh ➡Y O U T U B E ➳https://www.youtube.com/c/buywiseborrowsmart

📩 – info@theeducatedhomebuyer.com

For Show Notes, See Below 👇

[00:00:00] Jeb Smith, Huntington Beach Realtor: Affordability remains one of the biggest problems currently in the housing market. And because of that, we’re starting to see more and more parents, relatives, family members help out potential buyers in giving gift funds in order to purchase homes. And there’s a lot of little caveats when it comes to gift funds.

So in today’s episode, what we wanna do is dive into gift funds in a little bit more detail. Go through what you need to know as a first time home buyer, as someone planning to use gift funds when buying a home in order to become a more educated home buyer. So Josh, I think I wanna start today by just, very basic, what are we talking about when we’re talking about gift funds?

[00:00:55] Josh Lewis, Expert Mortgage Broker: So assume that you don’t have enough money to complete your purchase, make your down payment, cover your closing costs. An acceptable source of funds to close that gap is a gift. We’re gonna go through who eligible donors are, because you can’t just have random person down the street or one of the agents in the transaction hand you money.

There are sources that are eligible, but basically they are doing what it sounds like. They have sourced and seasoned funds and they’re able to gift you those funds and they become your good and valid funds for your down payment and closing costs. And in most cases, the gift can be all of your funds. In other cases, you may just be looking to close a shortfall. 

Maybe we need $27,000 for down payment and closing costs and you have $20,000. And mom and dad say, “No worries. We got 7,000 for you for a gift.” But we’ll go through all of that. We’ll go through the different scenarios, the different loan types.

What I can say is gifts in today’s day and age and have been for the last 15, 20 years, very flexible, nearly any program that most of your first time buyers, and not that it’s limited to first time buyers, but a large portion of our audience is first time buyers. So those folks, in most situations, if you are buying a home with Fannie Mae, Freddie Mac, FHA, VA, USDA loans you can use gift funds.

[00:02:10] Jeb Smith, Huntington Beach Realtor: Yeah and just to clarify, in today’s episode, we’re not talking about borrowing money from a credit card, taking money outta your 401k, getting funds from any other source other than a gift. And in fact, we’ve talked about down payments in another episode but this episode spun off because we had some specific questions from viewers, from listeners asking about gift funds.

So we did wanna take the time and actually dive into it because it’s going to become, in my opinion, Josh, probably more and more popular as housing affordability remains an issue out there, right? We’re likely to continue to see home prices stabilize, appreciate in the low single digits, interest rates are likely to come down, but with that we’re gonna get some buyer demand and in turn, probably drive house prices up a little bit further.

And as a listing agent or as an agent [00:03:00] in general, what I’ve seen more and more commonly over the last couple of years is family members either taking equity out of their property, giving it to their kids early so that they can buy a home. Because a lot of, you know, homeowners at the moment, in that middle aged older demographic, start to see the housing market and the likelihood that it continues to go up and how unaffordable it’s going to be in years to come. 

And so what they wanna do is help out family members now. Give them the gift now. Get to see them enjoy that gift, be able to purchase a home and create that generational wealth that we talk about on top of grandma’s and grandpa’s giving inheritances early in order to be able to take advantage of housing.

We’re gonna dive into that a little bit more detail, Josh, but when we’re talking about gift funds, What can the gift funds actually be used on? Are they just for down payment? Is it for closing costs? What can it cover and how much can be covered? 

[00:04:01] Josh Lewis, Expert Mortgage Broker: If you get into a jumbo loan or a non QM loan where we’re talking about debt service coverage ratio, or bank statement loans, those are unique, gonna be their own thing, and there’s gonna be some limitations.

But for the big five that we talked about, Fannie, Freddie, FHA, VA, USDA, it can be used for anything. You literally don’t have to have any of your own funds. And what I should say, Jeb, is we’re going to talk the 99% today. In 99% of situations it’s basic vanilla guidelines. There are some little quirks at the edges that very rarely come into play.

So it’s important that your loan professional know them so that if there’s a little red flag, they go, Hey, we gotta look over at this little corner of the box. But for 99% of your Fannie Freddie, FHA, VA transactions, you can use gift funds for all of the down payment, all of the closing costs, all of the prepaids, and you can get in with no money of your own.

In most situations where you’re able to get an automated underwriting approval, if reserves are required, the gift can be used for reserves. I’ve had transactions, Jeb, where we couldn’t get an automated approval and we needed reserves. So the borrower didn’t need a gift. They had all their own money, but they got a gift to show that they had two months of payments in reserve post-closing, and magically we got an automated approval.

So there’s a lot of things that it can be used for, but what are really the big things in a file? Down payment, closing costs, prepaids and when needed reserves. And for the most part it can be used for all of those five programs, for all of those four items. 

[00:05:29] Jeb Smith, Huntington Beach Realtor: So basically what I’m hearing you say is that you can buy a home as a first time home buyer, even as a move-up buyer, not really have any of your own funds and still get away with purchasing a home. Really no issues. As long as you can meet the other qualification guidelines. 

[00:05:44] Josh Lewis, Expert Mortgage Broker: A thousand percent. And not that anyone wants or needs a history lesson. I started in the business in the mid nineties, and back then conventional loans required you to have 5% of your own funds. So you could get a gift, but you had to have five of your own funds.

That is long gone. So Fannie, Freddie [00:06:00] do not require that. FHA never required it. VA doesn’t require a down payment. Have always been willing to allow you to get a gift for your closing costs and prepaids. USDA, same thing. No down payment, but obviously closing costs involved there. And we can get a gift for those.

So we’ll transition and go through the important pieces of what you need to know on each of those. But really for 99% of buyers, they’re going to use one of those five programs. We can use gift funds, and you do not have to have any of your own funds. So again, painting with broad strokes here so I cannot guarantee you that you don’t need any money of your own, but per the guidelines, you do not. 

[00:06:40] Jeb Smith, Huntington Beach Realtor: Now be, to be clear, anybody listening, we’re talking primary residences here, right? We’re not talking second homes, we’re not talking investment properties. The guidelines are a little bit different there. For the majority of our audience, the educated home buyers out there.

We are talking buying your first home, whether it be a condo, town home, single family. This is what we’re talking about. Josh, let’s talk with probably the most popular type of loan out there is conventional, right? Conventional financing. We’ve already determined that more or less the entire down payment, closing costs, everything can be covered, but is there any specific guidelines to conventional that we need to know about when talking about gift funds?

[00:07:18] Josh Lewis, Expert Mortgage Broker: So the minimum borrower contribution, do you have to have any of your own funds? And the answer is no as long as you’re buying one unit. And when we say one unit, it could be a manufactured home, single family home, condominium, town home. Anything that’s one unit, not 2, 3, 4 units. Now, if you’re buying two to four units, gift funds are still acceptable, but we do fall back to what we just talked about a minute ago.

You need 5% of your own funds on a standard Fannie Mae, Freddie Mac purchase. If you’re Home Possible or HomeReady eligible, you could get in with 3% of your own funds on two to four units. But in reality, there’s very few of those done. So for the vast majority of borrowers on conventional you are absolutely fine.

So the one that comes up all of the time is, okay, who can give me the money? Can my boss gimme the money? Can my best friend give me the money? And we’re gonna go through the details for each one of these loan programs. They all define it slightly differently. What I can say is, in 27 years of doing this, I have never had a disallowed donor.

Now maybe that’s because on the gift letter, it’s just always stated as a tighter relationship so I’ve never seen one that would be disallowed. But we’re gonna give you the actual definitions. What I’ve seen is underwriters do not police this. They take your word for it, that you are telling them the truth. And you’re gonna hear that these are very wide definitions of who an acceptable donor is.

So for Fannie Mae it’s defined as the borrower’s, spouse, child, or dependent or any individual related by blood marriage adoption or legal guardianship. They can also be a non-relative that shares a familial relationship. What does that mean? Domestic partner, fiance, A former relative. So your ex sister-in-law, you guys are still tight. She wants to give you a gift. Totally cool. Godparent. 

So you’re starting to see these are pretty loose definitions. No one says, [00:09:00] do you have the godparent license? I have a God child. I don’t have any documentation showing that she’s actually my God child. If that goes on the gift letter, we’re going to be fine.

Now, if we talk about Freddie Mac, so Fannie Mae and Freddie Mac, we talk all the time on the show that 90, 95, maybe 98% of their guidelines overlap. But there’s little differences at the edges, and one of the differences here in their definitions. 

Freddie Mac adds that unrelated persons can give wedding and graduation gifts. You can also get a gift from the estate of a related person. A trust established by a related person. And we can also use unrelated individuals with close family-like ties to the borrower. When we go down to FHA, you’re gonna hear something that sounds very similar. So if you’re going conventional, Freddie Mac allows someone with close family-like ties to you.

And let’s just jump to it. Jeb FHA, they have an interesting definition here, and it’s of course I didn’t get it in here, but basically the same thing that you have a documentable family-like relationship that you can show. So in essence, it’s someone that has a long-term interest in you and isn’t just randomly popping up and dropping money into your lap.

So all the way through on this stuff, conventional, either Fannie Mae or Freddie Mac, we’re going to be able to find a way for an acceptable gift donor. In terms of the last piece of how do we document that your donor has the ability to give you the gift? All of these programs require us to show that the donor has the ability to gift.

Just like they want us to source and season your funds. We have to source the funds from the donor. Now, conventional is the easiest of all of them because what they will allow you to do, if the donor wires to your account at escrow, so at close of escrow, the money just wires in. Say they’re giving you a $20,000 gift from their Bank of America account, they wire in $20,000 from Joe Smith’s Bank of America account. That is accepted as documentation. 

And what you’ll see when we go through FHA, a little bit more complex than that. So conventional, very open, don’t need to have any of your own funds, have to have a relationship that is acceptable. We have to document it with a gift letter, and we’re gonna go through the details of that gift letter.

And then we have to document the source of funds, which can generally be done with a wire at close of escrow so that your donor doesn’t have to actually give you one of their bank statements or give me or your loan officer one of their bank statements to show that they have the ability to make the gift to you. Their funds showing up at escrow is the source of the funds. 

[00:11:38] Jeb Smith, Huntington Beach Realtor: And something to keep in mind, if you’re somebody that thinks you’re going to be getting a gift before you start having family members give you cash or give you checks or wire money into your account, or start moving funds around, have the conversation with a mortgage professional because What we see oftentimes, Josh, is I hear you in the [00:12:00] other room, yelling because you having to source all of these things and it’s going from one account to the next, and then they decide once it gets there, they’re gonna transfer it in their savings and then, oh, we’re now, we’re gonna go from the savings back to this account. 

And every time that money moves, it has to be sourced and it creates a paper trail that can be cumbersome to say the least, and a complete pain in the ass if we’re being completely honest. So if you’re having the thoughts of gifts and you’re listening to this thinking, yes, my money is going to be coming from that source, have the conversation with your lender before you start moving things around because it will save your lender headache. It’ll save you a headache. It’ll save the donor a headache because oftentimes that donor can start having to source things too when it goes the wrong direction. So just word to the the wise there when doing gift funds. 

So Josh, we talked about conventional. We’ve talked about FHA. Does VA, does USDA differ in these situations? 

[00:12:56] Josh Lewis, Expert Mortgage Broker: VA and USDA are pretty simple, but let’s close the loop on FHA. Are gifts allowed? Yes. Do you have a minimum borrower contribution? No. They have a slightly different definition for an eligible donor, but you’re gonna see it’s very broad.

Eligible donors are family, employer, or labor union… I did have in my notes here, I just couldn’t find it… close friend with a clearly defined and documented interest in the borrower. That basically encompasses almost anyone who would be willing to give you five, 10, $15,000 to buy a home. A charitable organization, government agency, or public entity that provides assistance to low to moderate income borrowers or first time home borrowers.

Pretty broad. Almost anyone can give you the gift. As long as we can document a good and valid reason. Now, here is the fun part with FHA, we must get the donor’s bank statement. So as Jeb was pointing out, where can this get sticky? Let’s say that you have a super private donor. I get this all the time, and they say, pound sand. I’m giving ’em $50,000. I’m not giving you anything. 

And I say cool, we can’t use FHA financing. You don’t have to show me anything, but the bank doesn’t have to give them a loan. And this is an FHA guideline. There’s no way around it. You can’t go to a different lender. This isn’t investor overlay.

This is literally from the top down. We have to have a bank statement. And the area where it can get sticky, maybe the donor doesn’t have a privacy problem. They go, cool, here you go. And they have 350 Venmos in and out of their account last month. It can get sticky. It can get ugly. So does that mean don’t do gifts on FHA?

No, we do ’em all the time. It just means we need to know upfront what we’re doing. We want to get that bank statement as early in the process so if there are issues, we can work through that early versus late when it’s stressful. So FHA super flexible. Fannie/Freddie super flexible. 

Now, VA and USDA Jeb are a little bit interesting. We said this can be used for down payment or closing costs or prepaids. We don’t have any down payment requirement on VA or USDA. Both of them will allow you to use gift funds. Neither of them have a minimum borrower contribution. Again, slightly different definitions, and these guys get super flexible with their definitions of an eligible donor.

[00:15:00] VA says A donor with no affiliation to the builder, developer real estate agent, or any other interest party and USDA makes it even shorter and easier. Anyone that does not have an interest in the sale of the property. So they’re gonna give you a very broad berth in who qualifies as an eligible donor, and they both will also allow you to wire into escrow at closing without getting the borrowers proof of funds.

So hopefully what you can see, gift funds are very powerful. You can use them for any and all funds that you need. Most anyone is going to be an acceptable donor and all of the primary loan programs that you would use as a first time buyer, and they’re not limited to first time buyers. Other than if we were getting as you saw in that definition of an FHA where it was a public entity giving you the down payment, but very flexible, very powerful, and pretty easy to use on all of the loan programs you’re likely to use 

[00:15:51] Jeb Smith, Huntington Beach Realtor: Good stuff. Really only leaves two different loan programs that we haven’t really talked about, which are jumbo and non qm. Being non-qualified mortgages, guidelines are a little bit different with those because of how the loans are structured. But I realize Josh, probably case by case in these scenario is really hard to define the actual guidelines cuz it’s gonna be different for every scenario or more or less the same but different between the two.

[00:16:15] Josh Lewis, Expert Mortgage Broker: So it, it’s funny, most of your jumbo lenders that have the absolute best terms are incredibly strict. They still are adhering to 43% debt to income ratios. Most of them have a minimum borrower contribution of at least five percent. Some of them won’t allow gift funds at all. Some of them require reserves on top of that.

But there is a subset of jumbo loans that we’ve seen popularized over the last four or five years that they do jumbo loan amounts, but they follow Fannie Freddie guidelines. So we run it through desktop underwriter. We get approved, ineligible for loan amount, but they will still do the loan. And in those situations, most lenders that follow the Fannie/Freddie guidelines will allow gift funds.

So if you’re looking at the jumbo loan, there are definitely lenders that will not allow gift funds or at least not allow them as flexibly as we just talked about. But there are those that will. I’ll also say the same thing on the non QM side. It’s gonna be case by case. There is almost a lender for every borrower in that non QM bucket.

Unlike other loan types, if you’re looking for a bank statement loan or a debt service coverage ratio loan, we really wanna shop that among 7, 10, 12 different lenders because there can be a very wide range of interest rates. They also have a very wide range of guidelines. So if you need to use gift funds on one of those programs, we probably wanna shop for a lender that will allow it because they are out there. But it’s not necessarily widespread where the majority or most will allow it.

[00:17:38] Jeb Smith, Huntington Beach Realtor: Now and something to also understand that any of these loan programs that require you to have your own, part of your own funds, HomeReady, 3% of your own funds, buying two to four units needs 5% of your own funds, doesn’t mean you have the funds, you can put them up, you could still get the gift for a larger amount. Is that right, Josh? And just use a portion of it towards the down payment? Or does [00:18:00] that entire gift that gets deposited, say, into your account, have to be used on the transaction? 

[00:18:04] Josh Lewis, Expert Mortgage Broker: There’s not a problem in most of these, again you start getting into the details, most of them do not have a problem with you receiving funds back at closing. So let’s say you had made an initial $10,000 deposit. It’s 25,000 left to close, and you get a $35,000 gift wired into escrow. You can get the $10,000 back in most situations. Again, talk to your lender, talk to the person that’s pre-approving you, let ’em know what you’re looking at doing and have them confirm it.

And just wanted to clarify, Jeb, that HomeReady home possible 3% requirement is only, again, if you’re using two to four units. So if you’re only one unit, you are still good on HomeReady Home possible with none of your own funds. 

[00:18:41] Jeb Smith, Huntington Beach Realtor: Good stuff. So let’s talk about what is actually needed. We’ve talked about, a wire transfer is good enough on conventional financing. We’ve talked about the idea of a bank statement on FHA financing. What goes along with that statement that clarifies who the money’s coming from, how much is being gifted? The relationship, that sort of thing? 

[00:19:02] Josh Lewis, Expert Mortgage Broker: Absolutely. So it’s a gift letter and people always ask does the lender have a gift letter? Is there a gift letter? There’s a generally accepted template that will work for all of these loan programs, and it needs to include some basic information. They want to know all the info about the donor. They wanna know their name. They wanna know where they live. They wanna know their email, they wanna know their phone number so they can communicate with them if they need to clarify anything. 

They wanna know the amount of the gift. They wanna know when the gift is being given. They wanna know what account it is coming from because even in the instances where we’re not showing a bank statement, we are showing the wire in to escrow and we have to match up from the gift letter to the wire into escrow that the names and the accounts and the account numbers match. So that’s the important stuff. 

We need to list what is the relationship? We covered here that just about any relationship is acceptable, but we want to document what the relationship is, who the recipient is, what property they’re buying, so we can identify the transaction that this gift letter applies to.

And the absolute most important thing in the gift letter, it has to state that this is a gift and no repayment is required, implied. No side agreements. That I am truly giving you a gift and there’s no expectation of repayment or a loan. 

[00:20:13] Jeb Smith, Huntington Beach Realtor: Wink, wink. Uh, yeah. So, We’ve talked about the loan programs, we’ve talked about what is required on gifts.

It’s relatively easy in my opinion to understand and get the gist of it. For the majority of people out there, you’ll be able to listen to this and apply it relatively simply in buying a home. But like we’ve talked about, make sure you’re talking with your lender, having that conversation before you start moving things around or before you get the funds in hand.

But Josh, one thing we haven’t talked about is gifts of equity, right? So sometimes you’re buying a family member’s home. And in order to do that, they’re saying, “Hey, The home’s worth 500,000. What we’ll do is we’ll sell it to you for 400,000”, giving you a gift of equity of a hundred thousand dollars in order to purchase this home.

I heard you say with USDA that you know, that may or may not [00:21:00] work. So gifts of equity, are they allowed on all programs? Is there any nuances here? Anything we need to be aware of? 

[00:21:06] Josh Lewis, Expert Mortgage Broker: They’re slightly tighter guidelines. I’ve never had a problem with a gift of equity. And it is exactly what Jeb said. You have a family member, an eligible gift donor that is willing to sell you their property at a lower than market price. So we get an appraisal showing the market value and the gift they’re giving you is the equity difference between what they’re willing to sell you the home for and what the market value of the home is.

That amount is then eligible to be used to be considered your down payment, to cover closing costs, to cover your prepaids. So a fairly easy concept, it gets a little bit trickier. And what I will say, Jeb, this is probably the gift situation that I get the most calls, inquiries from people who say, I talked to a lender and they said we’ve gotta do this, or we gotta do that.

And it’s like it’s not simple, but if you have someone that’s experienced that knows how to do these, It is fairly simple. I have one right now from a listener of the show up in the state of Washington. His mother has a highly appreciated property. She wants to retire and move outta state. He lives in the property, he’s gonna buy it.

We’re gonna do FHA financing and we’re going to get that put together with him coming up with no money of his own, including using some of the gift to pay down debts for him to qualify. Very flexible, very powerful. So if you have someone with a highly appreciated property that they don’t need every last nickel out of their home, it can be a great way for you to get into a property without having to come up with any money outta pocket.

[00:22:26] Jeb Smith, Huntington Beach Realtor: And I don’t want to go off on a tangent here, but you said something really important there, that those gifts, those funds that are being gifted towards the down payment can be used to pay off debts in some cases, Josh. So if somebody were willing to gimme a hundred thousand dollars to buy a home, for example, a down payment on a home.

 Is it possible to take part of that, pay down my debts to maybe increase my debt to income ratio, put me in a better financial position overall and then use the remainder for the down payment and still be able to get that through with no issues. 

[00:22:55] Josh Lewis, Expert Mortgage Broker: I won’t say there aren’t any situations where you wouldn’t be able to, but in the vast majority of situations, you can absolutely use that gift of equity to pay down debt. You can use a standard gift. Let’s say you don’t qualify. You have a car that you owe $40,000 on and it’s got a thousand dollars monthly payment, and it’s throwing your debt to income ratio off. Your gift owner can give you $40,000 to pay that off at closing. Bring your debt to income ratio in line.

So it’s important that we talked about that. We talked about down payment, closing costs, prepaids reserves, but actually debt payoff is another acceptable use of the gift funds. 

[00:23:28] Jeb Smith, Huntington Beach Realtor: No good stuff. And I’m learning on the show as you listeners are as well. And like I said earlier, this episode came about because a listener reached out and had specific questions on it, and so Josh and I wanted to clarify this because if one person has questions, there’s a really good chance that a lot of other people have a similar question. And with that, I’m reaching out to you guys as an audience and asking if there’s something you want Josh and I to cover when it comes to mortgage.

When it comes to real estate, anything in that, that housing you know the [00:24:00] bubble if you will, the housing bubble let us know cuz we want to cover it. We want to give you guys what you want to hear in order to help you become more educated home buyers. So with that said, we appreciate you being here. We appreciate your time. Until next time, Adios! 

[00:24:14] Josh Lewis, Expert Mortgage Broker: Amigos.

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