Scraping together a down payment can be a challenge. Most lenders require a 20% minimum — regardless of the monthly mortgage payment that you can afford. There are many ways to come up with the cash, but if you choose to ask a family member or friend for help, remember: It can come with strings attached.
“Money has a way of challenging relationships,” says Lauren Kovar, a certified public accountant in Chicago. “You have to communicate upfront so that the money doesn’t become an issue that destroys the relationship.”
Lenders prefer to see gifts from family rather than friends, unless it’s a close, long-standing relationship you can document. But regardless of your relationship, it’s important to discuss boundaries and expectations before accepting any financial gift. Everyone manages their money differently, so choose your partners wisely. Consider this: If Mom and Dad are putting up some cash, they might feel entitled to a say in the home you buy, how much you spend on it, and maybe even what you do with it after you move in.
“If it’s a gift, you would want to communicate very clearly upfront that this is a gift and that you would feel uncomfortable if they had a say in how you spent that money,” says Kovar. “If you care whether someone tells you how to decorate and live in your home, then don’t do business with them.”
Even if your family member or friend doesn’t want to audit your finances before bestowing their monetary gift, lenders and the IRS have requirements that you and the gift giver need to consider.
Gifts can be taxed
If you’re gifted the money, it’s yours to do with as you please, but your lender may ask that the gift giver sign a document stating that it’s truly a gift and not a loan. Since the gift giver — rather than the recipient — pays taxes on gifts, there may be taxes involved at rates as high as 40%.
Gift taxes don’t kick in right away, though. Think through this scenario: You’re buying a home with your partner, and your parents are gifting the down payment. Each parent can give $14,000 a year — the 2015 annual exclusion — to both you and your partner separately, bringing the total gift to $56,000.
Anything above that $14,000 exclusion limit counts toward the $5.43 million basic exclusion, the amount an individual can leave to heirs without being required to pay a federal estate tax. The basic exclusion is frequently adjusted for inflation, as is the annual exclusion limit.
“The key with gifts is documentation so that you don’t have a situation if you get audited,” says Katherine Dean, managing director of wealth planning at Wells Fargo Private Bank. “If you’re giving the $14,000 to a child and their spouse, you would want to write one check for each gift.” Donors are required to keep track of gifts with IRS Form 709.
Time gifts right
When you deposit a gift into your account matters to underwriters: Applying for a loan the day after you receive a gift may affect your chances of obtaining a mortgage.
“Underwriters automatically assume that you don’t have the capacity to make your payments if they’re seeing an influx of cash in your account,” says Dean. “The way to get around this is to ‘season’ it by having it sit in your account for more than 60 days.”
If the gift isn’t seasoned, your lender may require a letter from the donor explaining that this money is a one-time gift and not a loan. And if your gift giver is reluctant to share bank statements with your lender, you may just have to wait. “The donor may also have to show their financials to the underwriter,” says Dean. “The lender wants to make sure that the donor can afford this gift as well and they want to see stability.”
There are other options
Many lenders ask for an abundance of information from borrowers — and anyone else involved in the borrowing process — to ensure their loans will not go unpaid. If you’re uncomfortable with your lender’s requirements or the input your friend or family member expects in exchange for a monetary gift, you do have other options.
You can take the traditional route and wait to purchase a new home so that you have time to save enough money for a down payment. Budgeting or taking a second job to help boost your monthly cash flow can help you build your savings more quickly. Purchasing a less expensive property that requires a smaller down payment is also an option.
Ultimately, buying a home should be an exciting time, with a big celebration once you’ve gotten settled into your new home. To make the process go smoothly and to maintain your relationships with friends and family, it’s worth the time it takes to plan things out. Then save a seat at the head of the table at your housewarming party for the friend or family member who funded your down payment as a way of saying thanks!
Have you accepted a gift from a friend or family member to pull together a down payment on a home? Share your advice in the comments below!