A former employee recently asked me about mortgage gift letters. She had just accepted a new job and would thus be buying a new house in a different area.
“My father-in-law is giving us some money to help with the down payment. Our realtor mentioned that the bank will probably want a ‘gift letter’ to back this up, but I’m not really sure exactly what they’ll be looking for,” she wondered aloud.
This is a great question. The short answer is that, if you’re ever in a similar position, the loan officer (or mortgage broker) should be able to tell you what they need to document the gift. They might even have a special form for the donor to fill out.
What’s a mortgage gift letter?
The slightly longer answer is that mortgage lenders want to be sure that they’re getting the full picture when underwriting your loan. And they also want to be sure that you have some skin in the game — hence the expectation of a downpayment.
But what good does it do them if the downpayment isn’t actually your money? What if it’s actually a secondary loan of some sort that you’ve taken on the sly? That’s what they’re trying to protect against when asking for a gift letter.
So, in order to assuage their concerns, you need to create a proper paper trail. You’ll either need to show that the money in question is indeed yours, or you’ll need to provide proof that it’s an honest-to-goodness gift, and not a loan.
This is where the mortgage gift letter comes in.
The letter should state that a gift of a specified amount has been made to assist with a property purchase. It should also list the relationship of the donor to the recipient and clearly state that there is no expectation of repayment.
Sample mortgage gift letter
Here’s a simple example of what such a letter might look like:
To <name of bank or lender>,
The purpose of this letter is document the fact that I/we intend to make a gift of <$XX,XXX> to my/our <son/daughter/whatever>, <recipient’s name>, to be used toward the purchase of the property located at <address, if known>.
There is no expectation of repayment of this gift, and I/we will retain no interest in the property being purchased.
The source of the funds for this gift is: <insert relevant details here>.
<donor’s name, signature, and contact information>
As noted above, the lender might have a specific form that they’ll want you to use instead of drafting a letter of your own, but the expectations will be similar.
About that paper trail…
Another important aspect of this process is that you’ll want the transaction to be easily traceable. Moreover, the donor should be able to provide documentation of the ultimate source of the funds.
So if, for example, the donor sold shares of a mutual fund to free up the cash for the gift, they should be prepared to provide a statement showing the transaction. The gift should then be made in the form of a check or wire transfer as opposed to cash.
For simplicity, deposit the check on its own so you’ll have proof of a transaction in the exact amount stated in the gift letter. Also, go ahead and deposit it directly into the account from which the downpayment will be made.
How big can the gift be?
If you’re getting a conventional loan, the lender will typically want to see that you’re also contributing some money of your own — on the order of 5% of the purchase price. So be prepared for that.
If you’re getting an FHA loan, the rules are different. In fact, with an FHA loan, you may be able to use a gift to cover the entire downpayment. Here again, it pays to check with your lender
What about the tax consequences?
As you’re likely aware, gifts that exceed the $14k annual gift tax exclusion need to be reported to the IRS. That being said, lenders aren’t responsible for doing this, so you’re on your honor for reporting it yourself.
But really, if you’re smart about it, this probably isn’t much of a concern. Depending on your circumstances, you can actually gift up to $56k in a single year without running into problems. How? Simple…
If you’re married and the recipients are also married, you and your spouse can each gift $14k to each of the recipients. And if you really want to stretch things, you can time the gift to occur in December and then do it again in January for $112k total.
If you decide to do this, it’s important once again to create a paper trail. Write separate checks for each $14k allotment in case the IRS comes calling, as that will make it easier to substantiate your case in the event of an audit.