Coming up with a down payment is one of the biggest hurdles buyers experience in their quest for homeownership.

With the cost of living and home prices increasing over the past several years, if you haven’t saved enough of your own funds for a down payment, gift funds can be the lifeline to making that happen. In this column, we’ll cover some rules about gift funds when utilizing them as a down payment source and some critical dos and don’ts. We’ll also touch on who can gift money, the amount that can be gifted, documentation requirements, and tips to make the loan underwriting process go as smoothly as possible.

First, it’s important to know that gift funds can be used to purchase either a primary residence or a second home. Gift funds may be used to purchase an investment property as long as it is considered the borrower’s primary residence. For a conventional mortgage, which is offered through Fannie Mae or Freddie Mac and is the most common mortgage available to consumers, the down payment gift must come from family. Family is defined by blood, marriage, adoption, or legal guardianship. Fiancés and domestic partners also count as family. The definition of family extends to aunts and uncles, nieces and nephews, cousins, and in-laws and may also include an adopted child, stepchild, and foster child.

For FHA loans, the definition of a family member is a little narrower. It does not include cousins, nieces, or nephews, but they do allow gifts from “close friends” with a clearly defined interest in the borrower, including extended family such as cousins, nieces, nephews, and even godparents. VA and USDA loans have the most liberal requirements for gift funds. They allow gift funds from pretty much anyone as long as that person does not have an interest in the transaction, such as the seller, builder, real estate agent, contractor, or mortgage lender.

In most cases, as long as the donor meets the qualifications, there’s no cap on the amount that can be gifted. If the total down payment is less than 20 percent of the purchase price, the borrower must contribute at least 5 percent down from their own funds. Gift funds may go towards the earnest money deposit, down payment, and closing costs. Additionally, a lender will usually allow the borrower to use gift funds to pay off certain types of debt, such as student or auto loans, to qualify for the loan.

Your lender will require a gift letter clearly defining the parties involved, the amount of gift funds, and confirming the funds are indeed a gift. Anytime you use gift funds, your lender will require documentation proving the money has been transferred. The cleanest way to transfer the funds, requiring the least scrutiny and documentation, is to have the donor send the gift funds directly to escrow. When this occurs, the only documentation the lender will require is the receipt from escrow showing the amount transferred and the donor’s name. When gift funds are being transferred before closing, the documentation is a bit more burdensome to both the donor and the recipient. You’ll have to provide documentation with the donor’s check and deposit receipt into the borrower’s account and a wire transfer receipt with the donor’s name. If you’re using bank statements to document the transfer, you’ll need to obtain both the donor’s and borrower’s bank statements.

A gift letter and documentation are not needed if the gift funds are transferred at least 60 days prior to the purchase. At that point, the funds are considered “seasoned” in the lender’s eyes, and no documentation is required to support the funds. It is always recommended to check with a reputable lender as a first step in the home-buying process. You can always feel free to reach out to us with any questions. spt