What Is A Gift Letter And How Do You Use It To Get A Mortgage?

There’s no better time to receive a large cash gift than when you’re house hunting. Traditionally, down payments on a first home were made with monetary wedding gifts, including relatively hefty ones from the parents of the bride and groom. Today, gifts are still welcome, but the rules about how they can be used are more stringent.

What Is A Gift Letter For A Mortgage Down Payment?

As it applies to your mortgage, a gift letter is a note from the donor that says you don’t have to repay the money. If you’re using gift money for part – or all – of your down payment, you’ll need the donor to write a gift letter to your mortgage company that makes it clear that the money is a gift and not a loan.

Here’s what your gift letter should include:

It’s important to understand that the gift letter itself may not be enough evidence for the mortgage company. Your lender will also want to verify that the funds are either in the donor’s account or have been transferred to the recipient’s bank, usually by asking for copies of the withdrawal and deposit slips or online statements.

You’ll probably want to let your generous friend or relative know this upfront, so they’re prepared to provide the proper documentation.

Mortgage Gift Letter Template

Your lender may provide you with a gift letter template. If that’s the case, you can simply pass it along to the gift giver and have them fill it out. If the lender doesn’t provide you with a gift letter template, be sure to verify the gift letter requirements.

If you aren’t given a template, here is an example of what your mortgage gift letter should look like:

By signing this gift letter, both the donor and recipient confirm that they didn’t receive the gift funds from any person, business or entity that has any interest in the property being sold or any person connected to the transaction. This includes the seller, real estate agent, builder, mortgage banker or any entity associated with them. The recipient and the donor also agree that the gift does not have to be repaid.

Why Do Lenders Care About Gift Letters For Mortgage Down Payments?

Lenders care about gifts that go toward mortgage down payments for a few reasons. The biggest reason is that because the housing market crashed in 2008, federal regulations now require lenders to consider the buyers’ debt-to-income ratio, or DTI, in order to make sure borrowers can repay their mortgages.

The Internal Revenue Service (IRS) also wants to ensure that the donors making the gifts are conforming to gift tax laws. Finally, there are government rules that scrutinize large cash transfers aimed at finding money laundering operations, which is why comprehensive documentation is key and gift letters are necessary.

How Do Gift Letters Affect Mortgage Underwriting?

Say you’ve just gotten married and received a considerable down payment gift. Although you may be excited to get that cash in the bank, you don’t want these deposits to cause problems when you’re trying to qualify for a mortgage. Let’s go over some additional details of how gift money affects mortgage underwriting.

Timing Of The Mortgage Gift Letter

As long as you have documentation for the past 60 days, your mortgage company can take it from there.

Mortgage Gift Amount

So, within that 60-day period, which deposits do you have to worry about getting a gift letter for? Let’s talk through a hypothetical situation.

You just got married. Aunt Sue gave you a $75 check, and Grandma Betty gave you $10,000 for tying the knot. Will you need gift letters for both deposits?

In general, your underwriter will need to verify the source of any large deposit. What’s the criteria for a “large deposit”? For conventional, Department of Veterans Affairs (VA) and jumbo loans, it’s any single deposit that exceeds 50% of the total monthly qualifying income.

For Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) loans, a large deposit is defined as any deposit that is greater than 1% of the home’s adjusted purchase price or appraised value, whichever is lower.

In this example, let’s say you took out a conventional loan. If you make $4,000 a month, any deposit over $2,000 would probably be questioned by your underwriter. Therefore, the underwriter will likely want to verify that Grandma Betty’s $10,000 gift is a gift, not a loan, so you’ll need to ask her for a gift letter. Aunt Sue’s gift, however, is small enough that the underwriter might not question it.

Of course, this is partially up to the underwriter’s discretion. If there are any deposits that seem to be out of the ordinary, your underwriter may question them regardless of your income. If you normally had $2,000 in your checking account and you suddenly have a deposit for an extra $8,000, they would want to verify that regardless of the purchase price/appraised value or qualifying income.

An underwriter would dig deeper into that situation to ensure it checks out. Although your Aunt Sue’s gift might not be questionable because it’s small, if it seems out of the ordinary, your lender may require gift documentation.

What Are The Limits On Gifts?

There are no limits on the amount someone can give you for a mortgage down payment or closing costs. However, depending on the loan and property type, you may be required to contribute a certain percentage of the down payment from your own funds.

Keep in mind that these rules are subject to change based on lending regulations, so check with your mortgage company for up-to-date guidelines.

How Loan Types Influence Gift Letter Regulations

Depending on the type of loan you’re getting, there are different guidelines regarding who may give a down payment gift to you. Let’s briefly go over those.

Conventional Loans

If you’re getting a conventional or conforming loan through Fannie Mae or Freddie Mac, the gift has to come from a family member. For the purposes of your mortgage, family is defined as follows:

If you happen to get a loan from Fannie Mae, they also allow gifts from future in-laws.

FHA Loans

With FHA loans, the gift has to come from the same family members as with a conventional loan, including future in-laws, but some caveats apply.

Although cousins, nieces and nephews aren’t able to give your gift under normal family guidelines with an FHA loan, the FHA does allow for gifts from close friends who have a clear interest in your life. This can include extended family, such as cousins, nieces, nephews and even former spouses.

In addition to the close friend guideline, the FHA also allows for gifts from the following:

Finally, you can receive funds from a government agency or public entity that provides homeownership assistance to low-to-moderate income or first-time home buyers.

USDA And VA Loans

The USDA and VA don’t place very many restrictions on who can give you a gift. The only stipulation is that it can’t be an interested party. An interested party is someone who is involved in the transaction directly or indirectly, including:

It’s also important to note that real estate agents can contribute to prepaid items and closing costs no matter who the investor is in the mortgage.

Gift Letter Requirements For Property Types

The type of property you’re closing on can play a role in how you utilize your gift funds. Below are a few examples of different property types and how monetary gifts can affect your mortgage down payment.

Primary Residences

If you’re buying a primary residence, you can use gift funds for your down payment. These guidelines apply:

Second Homes

If you’re buying a second home with a conventional loan (you can’t buy them with FHA, USDA or VA loans), the following guidelines regarding gift limits apply:

Investment Property

Gift funds cannot be used toward the down payment on an investment property.

What Are The Tax Implications On Gift Funds?

Tax laws change on a regular basis, and you should always speak with your financial advisor or a trusted tax professional in order to make sure you’re in compliance.

In general, you won’t be responsible for any taxes on gift funds. Your donor may be responsible, however, and it might be helpful for you to make sure they’re aware. The only occasion where you’d be expected to pay the gift tax would be if you’d agreed to pay it for the donor.

For 2022, the annual exclusion for gifts is $16,000, meaning donors can give up to this amount without having to report it. The gift exclusion rises to $17,000 in 2023.

If your donor gives you more than that amount, they’ll have to file a gift tax return to disclose the gift. Filing a return doesn’t mean that they’ll have to pay taxes on the gift, it just means that the amount has been counted toward their lifetime gift tax exclusion. This dictates how much money you can gift to a person over the course of your lifetime.

The Bottom Line

If you know that you’ll be getting any financial gift to help with your down payment, be prepared to document it for your mortgage company. Knowing what documentation you’ll need and what counts as a qualifying gift for each loan type will help streamline your application process.