Trouble Coming up With a Down Payment? Use a Gift of Equity

One of the biggest obstacles for first-time homebuyers, especially those who are young, is the down payment. With some loans, a 20% down payment is required, which is almost impossible for some hopeful homeowners to save on their own. If you’re buying a home from a family member or close friend and are in this situation, a gift of equity may be the solution.

What Is Home Equity?

As a homeowner pays down their mortgage, makes renovations, and lets time pass, they build equity in their home. Home equity is the dollar amount you get when you take the home’s value and subtract the amount you still owe on the property. Over time, a home’s equity ends up being more than what is owed on the mortgage note, and may be more than what the buyer even paid for the house. How fast the equity grows depends on the condition of the home and how “hot” the neighborhood is, along with other factors.

How Does a Gift of Home Equity Work?

If a homeowner sells their property to a family member or close friend, they may decide to sell below the market price. The difference between the market price and what the buyer actually pays is the gift of home equity. For example, if the home is valued at $300,000, and the buyer pays $240,000, the gift of equity is $60,000. This could be considered their down payment, so they wouldn’t need to come up with that much cash.

What Are the Requirements for Doing This?

To benefit from a gift of equity, you’ll need these things:

An appraisal. The appraisal will be necessary to determine the amount of equity in the home, which dictates how much the gift of equity can be.

An equity letter. This document outlines the selling plan, including the equity amount, which is based on the appraisal. The seller and buyer need to both sign this document.

A plan for paying the gift tax. If the gift of equity is more than $15,000, the seller would need to file a gift tax return, and the buyer could be required to pay taxes on it. If the gift is under $15,000, this won’t be a concern. It’s smart to consult a tax accountant to figure this out beforehand.

Other Important Information

Depending on the amount, a gift of equity could help the buyer avoid paying private mortgage insurance (PMI), which can add a significant amount to every monthly mortgage payment.

In certain cases, using a gift of equity for your down payment on a home is the best move to make. It can help a buyer get into a home faster than if they had to save up a down payment and, if they are first-time buyers, help them stop paying out money in rent.

If you’re wanting to buy a house from a family member or close friend, talk to your lender and see if using a gift of equity is the right move for you.