What Is a Gift Letter?

Saving for a down payment and committing to paying a mortgage for years can be daunting for home buyers. Receiving a generous cash gift from a friend or family member makes the dream of owning a new home more likely to come true. However, mortgage lenders require mortgage applicants to prove that gifts being used for down payments are not loans and do not have to be repaid. Therefore, you may need to obtain a gift letter from the donor stating that the money is a gift, not a loan.

Is a gift letter legally binding?

A gift letter is legally binding, and the donor and recipient must sign the document for it to be valid. Using a specific format or notarizing it is unnecessary, hence the word "letter." However, larger banks and lending companies provide gift letter templates, so it's a good idea to check with them before completing one.

Is a gift letter a legal requirement?

The government does not directly require prospective borrowers or donors to provide a gift letter, but lenders often require it to stay compliant with oversight and regulatory requirements established by the government.

Nowadays, the underwriting process is more stringent than in the past, primarily due to federal and state laws passed in response to the subprime mortgage crisis. However, gift letters are not a legal requirement. State and federal regulations for mortgage loans and processing do not universally require gift letters from prospective borrowers.

However, mortgage lenders face increasing responsibilities in ensuring that borrowers acquire funds legally. To protect their own interests and ensure the loans comply with strict standards, individual lending institutions may require gift letters as part of their application process. Prospective borrowers should reach out to lenders regarding their requirements for gift letters based on the source, size or timeline of the gift to ensure they can fulfill their documentation obligations in a timely manner.

Who can give you money for a mortgage down payment?

Donor requirements differ between lenders and depend on the type of mortgage financing you qualify for. These requirements include rules governing who can give you a monetary gift for a down payment on a home or to pay off your mortgage.

For instance, some loan programs stipulate that only blood relatives may provide monetary gifts for down payments. Others also allow stepparents and godparents. Other loan programs allow non-blood relatives and even charitable organizations to provide gifts.

Below are the most common types of mortgage loans and who can provide monetary gifts for each. However, it's advisable to contact your lender for more information.

Conventional mortgage

If you're obtaining a conventional mortgage, the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) require that down payment gifts come from family members. They consider blood relatives, in-laws, adoptive parents, legal guardians, fiancés and domestic partners to be family members.

Federal Housing Administration mortgage

Unlike conventional mortgage lenders that don't allow cousins, nephews and nieces to gift money, the Federal Housing Administration (FHA) does. The FHA also permits charitable organizations, labor unions, extended family, friends and employers to gift money for mortgage down payments.

VA loans and USDA loans

VA loans and USDA loans are home mortgages with fewer restrictions on who can gift money than other loan types. Anyone can provide a monetary gift if they aren't interested party contributions (IPCs).

According to Fannie Mae's real estate selling guide, IPCs are "costs that are normally the responsibility of the property purchaser that is paid directly or indirectly by someone else who has a financial interest in, or can influence the terms and the sale or transfer of, the subject property." IPCs include an affiliate who may benefit from the sale of the property, real estate agents or brokers, property sellers and property developers.

What should be in the gift letter?

Donors must clearly state that they didn't loan you the money and don't expect you to pay it back. If a donor is writing a gift letter, it should include the following information:

• The donor's name, current address and phone number (a home phone number is preferable)
• The donor’s relationship to the recipient
• The gift amount
• A clear statement that the funds are a gift and do not need to be repaid to the donor
• The source of the donation and, occasionally, proof that the donor had the ability to give the gift
• The intended purpose of the gift (i.e., to be used toward the down payment of a home)
• The date of the bank transfer (if applicable)
• The address of the property the borrower intends to purchase
• The donor's signature

The key purpose of the gift letter is to make clear that the funds are a gift and will not require repayment. Some lenders may require further information. For example, the donor must include a bank statement for an FHA loan. Different loans have different terms and conditions, so it's a good idea to research those specific to the loan you're applying for.

How much can someone gift?

Generally, lenders don't place a cap on how much money a donor can gift as long as they qualify according to the lender's terms and conditions. However, the borrower's credit score, the type of mortgage and the size of the down payment can affect the allowable gift.

A donor can gift the entire down payment of an FHA loan, but this depends on the borrower's credit score. For example, for credit scores of 580 or above, the minimum down payment is 3.5%. For those with a credit score between 500 and 570, the minimum down payment is 10%.
Conventional loans work differently, requiring borrowers to pay a portion of the down payment out of their own funds if the down payment is less than 20%. The amount one must pay out of pocket is dictated by the mortgage insurance company, and is required for mortgages with down payments of less than 20%. However, if the down payment is over 20%, a donor may gift the entire amount.

Can you pay back a mortgage down payment gift?

A borrower can’t pay back money given as a mortgage gift, as the donor has to supply funding with no expectation of repayment. If the borrower plans to repay the donor, it isn't a gift, and the law requires lenders to factor it into the DTI ratio; this ensures borrowers can service their mortgage. By withholding information about the source of your down payment, you're placing your loan qualification at risk. More importantly, it is mortgage fraud, a federal crime.

Can you use gifted money for buying a second home?

Traditionally, gifted money was for first-time home buyers who couldn't afford the down payment. Nowadays, donors can gift money to purchase a second home. However, if a borrower uses the gifted money to buy a second home or investment property, they must pay 5% or more of the down payment.

What are the tax rules for gifted money?

According to the IRS, the following rules apply to gift taxes:

• Donors are usually responsible for paying taxes on gifted money, but the recipient can agree to pay the tax if special arrangements exist. The IRS advises you to visit a tax professional if you're considering this type of arrangement.
• The IRS considers money or anything holding monetary value transferred to an individual, either directly or indirectly, a gift.
• The IRS provides exceptions to the gift tax rule that include gifts that are not more than the annual exclusion for the calendar year, tuition or medical expenses you pay for someone or gifts to your spouse.
• You can't deduct the gift amount from your federal income tax.

Note: The annual exclusion maximum limit is $16,000 in 2022. This limit will rise to $17,000 in 2023.

How to document the gift

Lenders require the following documentation:

• Bank statements
• Wire transfer record (if applicable)
• A copy of the gift giver's check to the title agent
• Copies of the check and the buyer's deposit slip
• A copy of the settlement statement showing the gift was deposited

To avoid having to provide the above documentation, you can "season" your money by keeping it in your account for a certain period. Generally, if the funds have been in your bank account for two months or more, lenders consider it seasoned. Be sure to do your research and speak to legal counsel before making any significant financial decisions.