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The real estate market hasn’t been as friendly to the first time home buyer as of late. Between high interest rates and low inventory, 2023 was the year you didn’t buy a house for many Americans. Dig a little deeper, however, and you’ll find several solutions that could make it easier to meet the requirements to buy a house in 2024—some more appealing than others. From living with mom and dad to putting 3% down instead of the standard 20%, you have options. An often overlooked approach is the gift of equity. We’ll uncover what it is, how it works, and how it might help you get closer to your dream of becoming a first time home buyer.
Types of Home Transactions and Why They Matter
Perhaps you stumble upon that must-have address by simply driving by. You may be deep into a months-long search that’s exhausted every online home buying platform. But no matter how you arrive at the home-sweet-home you’d like to call yours, it’s most likely that its current owners are also unknown to you—a.k.a. at arm’s length. Therefore, all those involved in the transaction act in their self-interest without undue influence from each other. The transaction’s terms and conditions are typically determined through a negotiation process where both parties aim to achieve the best possible outcome for themselves.
A non-arm’s length transaction, however, involves parties with a pre-existing relationship or connection, which can influence the terms of the transaction. Think selling a property to a family member or business partner. There’s a level of trust and familiarity there that could impact the negotiations or terms of the deal. Non-arm’s length transactions require scrutiny to ensure that the terms are fair and that both parties are not taking advantage of the relationship for personal gain.
For a first time home buyer, non-arm’s length transactions can be pretty beneficial, as you can draw up the contract to meet your exact needs. You and the person you know set the requirements to buy the house. You’re also saving 6% on commissions by not using a realtor in the transaction since you’re keeping it between families.
Defining Gifts of Equity for First Time Home Buyers
Because of the challenges that first time home buyers face, more and more of them are coming to the table with family money. 38% of recent homebuyers under age 30 used a cash gift from a family member or an inheritance. Family members can also give a gift of equity instead of a down payment. The giver sells or transfers the property to the recipient for less than its current market value, with the difference between the market value and the actual sale price or the gifted amount considered the “gift of equity.” This type of exchange requires trust, which is why it more commonly occurs when the seller has a personal connection to the buyer, like a parent selling to their child.
How a Gift of Equity Helps Satisfy Requirements to Buy a Home
A gift of equity is different from a cash down payment gift, with which you may be more familiar. A cash down payment gift involves providing funds to assist a first time home buyer with the down payment, or in some cases, the closing costs and the recipient secures a mortgage to purchase the property. The recipient can use the gifted funds as part or all of the down payment, and there’s no direct transfer of ownership interest in the property.
A gift of equity, however, involves the direct transfer of ownership interest in a property, with the equity in the property being transferred at a price below market value or as a gift. For example, if the home is worth $400,000 and sold for $300,000, a $100,000 gift of equity is created, equivalent to making a $100,000 down payment on the home.
Simply put, a gift of equity involves the seller agreeing on a below-market purchase price, while a cash down payment gift doesn’t involve the seller at all, and is simply money gifted by a family member or friend of the buyer.
Requirements to Buy a House with a Gift of Equity
A gift of equity can benefit a first time home buyer, but this gift can’t come from just anyone. Typical scenarios include gifting between:
- Family Members – parents can gift equity to their children, grandparents can gift equity to their grandchildren, and siblings can gift equity to each other.
- Close Relatives – Aunts, uncles, and other close relatives can potentially gift equity.
- Spouses – After exchanging vows, married couples can exchange the gift equity with each other.
- Non-Family Members – In some cases, individuals with a close personal relationship may also be able to gift equity. This can include close friends or individuals with a significant personal connection.
Both buyer and seller must meet the mortgage lender’s requirements around the eligibility of the relationship. The Federal Housing Administration (FHA) only allows for such gifts between family members. Fannie Mae regulations grant gifts between the borrower’s spouse, child, dependents, fiancé, fiancée, or domestic partner, and any individual related by blood, marriage, adoption, or legal guardianship. Because it varies, if you’re considering using a gift of equity as a first time home buyer, be sure to dig into the requirements and documentation your lender requires. Here are a few other things to keep in mind:
Consider the fair market value. While the gift of equity involves selling the property at a price below its market value, the transaction should still be reasonable and comply with fair market value standards to avoid potential tax implications.
Speaking of…Research the tax implications. The giver and recipient should be aware of potential gift tax consequences. Ask your tax professional or legal advisor to understand and prepare for any issues.
Discuss with your lender. If you’re obtaining a mortgage to finance the property purchase, your lender may have specific requirements and documentation regarding gift-of-equity transactions. Partners like the Moreira team are skilled in facilitating such gifts and can help you navigate the process once you find a home you want to move forward with.
Properly document the transaction. The seller must certify that the gift of equity is a true gift, not a disguised loan. Often they will write a gift letter outlining the details to ensure clarity and compliance with any legal requirements.
What Kinds of Gifts of Equity are Available?
The requirements to buy a house using a gift of equity vary from lender to lender. As noted, the FHA allows gifts from family members only. Because Veterans Affairs (VA) and U.S. Department of Agriculture (USDA) loans have 0% down payment, equity gifts are rare. If you’re looking at a conforming loan, even those differ regarding the requirements. Fannie Mae allows gifts if the buyer and seller are related by blood, marriage, or legal guardianship. Freddie Mac says a gift of equity is an eligible source of funds provided the funds are from a related person. For down payments over 20%, at least 5% must come from the borrower’s funds.
A gift of equity can help a first time home buyer enter the market, whether that gift lowers savings needed or serves as all or part of the down payment. Rule number one: do your research. As you’re exploring neighborhoods and dreaming of that perfect home, it’ll serve you well to align with a partner from the start—one like Moreira. With years of expertise, our team can aid in your search, help you navigate the home buying process, get you the best rate possible, and pop the champagne with you on closing day.
Get a quote today—the requirements to buy a house are easily achieved when done together.