Borrowers who are struggling financially can benefit tremendously from an FHA loan, which requires only a minimal down payment with a modest credit score. Sometimes, though, an FHA loan alone isn’t enough to get someone into a home. This is where FHA gift funds can make a difference.
FHA gift funds can give borrowers the boost they need to qualify for an FHA loan or more easily afford it. These gift funds are especially beneficial for first-time home buyers and low-income borrowers who may still need a bit more help financing a home. That said, it’s crucial for borrowers and donors to follow specific guidelines to ensure the gift funds are valid.
Let’s take a close-up look at FHA gift funds, with an emphasis on how they work and how borrowers are allowed to go about using them.
What Are FHA Gift Funds?
FHA gift funds are cash or other assets a borrower receives without obligation to repay. The donor provides financial assistance to a borrower who’s unable to meet the expenses of an FHA mortgage loan on their own. For example, a borrower may use FHA gift funds to help cover their closing costs, make a down payment or beef up their cash reserves.
FHA Loan Overview
Backed by the Federal Housing Administration, an FHA mortgage is a type of non-conforming loan that borrowers with a less-than-stellar credit score, and perhaps not a lot of money for a down payment, often use as an alternative to other loan options. By insuring FHA loans, the federal government reduces the risk for lenders.
Homeownership is expensive and qualifying for a mortgage can be challenging. FHA home loans soften the blow by lowering specific financial standards for borrowers. For example, FHA loans help make homeownership possible for borrowers who lack the credit score to qualify for a traditional, lender-backed conventional loan or a USDA loan.
FHA gift funds are only valid for FHA loans. Borrowers must meet the following criteria to receive an FHA mortgage loan:
- The home must become the borrower’s primary residence.
- The borrower has 60 days to move into the property after closing.
- The house must pass an inspection for FHA minimum property standards.
- The borrower must be able to afford the mortgage insurance premium (MIP) for the loan.
- An appraiser approved by the FHA must assign the home a dollar value.
- Those with a credit score of 580 or higher must put down 3.5% of the purchase price.
- Borrowers with a credit score of 500 – 579 need a down payment of at least 10%.
FHA gift funds are advantageous for all borrowers, but especially those who have a credit score of 579 or less and must make a larger, 10% down payment. For example, a borrower who would otherwise qualify for an FHA loan for $150,000 might not have $15,000 in the bank. An FHA gift fund can give a borrower the assistance they need to make the minimum down payment and qualify for the loan.
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FHA Gift Funds Vs. FHA Gift Letter
Gift funds are an excellent way to afford a home when paired with an FHA loan. However, you’ll need a gift letter to ensure that the gift is a help instead of a hindrance. The gift letter spells out who the donor is and how they know the borrower. It assures all parties involved that the money provided won’t act as a loan and that the one-time gift is independent of the borrower’s ability to afford their monthly mortgage payments.
When purchasing a home, you’ll submit bank statements to your lender showing you have sufficient income for your mortgage payments. The U.S. Department of Housing and Urban Development (HUD) wants to see consistency and a regular cash flow in your bank account. Because gift funds are a one-time large deposit, they sound alarm bells for underwriters reviewing your financial information.
This scenario is where a gift letter comes in handy. You’ll need to provide a gift letter for any gift that surpasses 1% of the home purchase price or the home’s appraisal value (whichever is higher). For the letter to be valid, it must declare that the money you received is a gift with no intention of repayment on the recipient’s part. Otherwise, the money could be a second loan that will affect the borrower’s ability to pay their mortgage.
The donor’s gift letter should contain the following crucial information:
- The donor’s name, address and phone number
- The recipient’s relationship with the donor
- The cash value of the gift
- The donor’s motive for providing the gift
- The donor’s assurance of no expectation or contract for repayment for the gift
- The address of the home being purchased
- The donor’s signature
Donors can make as sizable a gift as they wish, with no tax implications for the borrower. However, gifts of a certain size may have tax implications for the donor. For 2023, a taxpayer can give up to $17,000 to one individual or to multiple people without incurring gift taxes.
How Do FHA Gift Funds Work?
Donors who want to provide an FHA gift should follow a specific process to eliminate obstacles for themselves and borrowers. First, donors must have specific reasons for making a gift and should state this in their gift letter. The goal is to ensure HUD the money isn’t in any way a loan.
Next, it’s critical for the donor and borrower to submit bank statements showing the transfer of money from the donor’s account to the borrower’s. The documents are proof of the gift amount and the date of the transfer.
These steps will make gift funds of cash simple for borrowers to receive. However, donors can also bestow gifts of equity instead of money. In this situation, the donor sells their home for significantly less than its value.
For example, a parent may want to sell their home to their adult child at a steep discount. Let’s say the home is worth $250,000 but the parent wants to pass it on for only $125,000. The transaction will grant the borrower access to $125,000 of equity. The adult child can then use the equity as a down payment to help obtain approval for an FHA mortgage loan.
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FHA Gift Funds’ Guidelines
Borrowers must qualify for an FHA loan to receive FHA gift funds. Besides FHA loan standards, HUD has these FHA gift fund requirements for borrowers:
- Gifts must originate from valid sources, such as bank accounts, bonds or stocks.
- Borrowers must provide documentation showing the gift transferring from the donor to the borrower’s bank account.
- Donors must supply a gift letter stating that the funds aren’t a loan.
- Gifts can be as large as the donor wants, but bigger gifts may have tax implications.
- Borrowers using their FHA gifts for varying purposes may need to provide sufficient supporting documentation.
Who Can Give Gift Funds On An FHA Loan?
FHA guidelines limit who can give FHA gift funds. Fortunately, a broad range of people and entities can provide FHA gift funds.
FHA Acceptable Gift Donors
Here’s a list of acceptable FHA gift donors:
- Family members – including cousins, nieces and nephews – with a dedicated interest in your life
- A charitable organization providing financial aid
- Your employer or union
- A close friend with a strong demonstrated interest in your life
- A government program that provides assistance to first-time home buyers
FHA Unacceptable Gift Donors
Unfortunately, not anyone can give FHA gift funds. HUD regulations won’t allow FHA gift funds from these sources:
- The property seller (if they aren’t a family member making a gift of equity)
- A business entity, regardless of who owns the business
- Mortgage lenders
- Home builders
- Real estate agents
The Bottom Line
FHA loans help borrowers afford a mortgage they otherwise wouldn’t be able to afford, in many cases. When this government program isn’t enough, FHA gift funds can enable borrowers to afford a down payment, pay closing costs or pad their mortgage reserves. For gift funds to qualify, they must come from a valid source and have a gift letter releasing the borrower from obligations to repay the money.
FHA gift funds can come in the form of cash or a gift of equity in the home the borrower purchases. As a result, gift funds allow more borrowers to move forward with an FHA loan upon receiving loan approval.
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Ashley Kilroy
Ashley Kilroy is an experienced financial writer who writes for solo entrepreneurs as well as for Fortune 500 companies. She is a finance graduate of the University of Cincinnati. When Ashley isn’t helping people understand their finances, you may find her cage-diving with great whites or on safari in South Africa.
