Gifts help the real estate world go ’round. Figures from the National Association of Realtors show that 24 percent of all first-time purchasers and 8 percent of all repeat buyers get a little help from family and friends. Without gift money, a large percentage of the real estate market would stall, there would be less demand and home prices would be weakened.
The catch is that in the world of lending, not every check counts as a gift. A “gift” in real estate is generally money provided to a buyer by family members, but gifts can also come from friends, employers, unions, charities and government agencies.
“Gifts” from sellers, real estate professionals, lenders and builders are off limits – in the lending game, such giveaways are considered a form of back-door discounting and that’s not allowed.
So what makes a gift legitimate? Lenders have a number of tests, but probably the most basic is this: A gift must really be a gift. The donor must state in writing that no repayment is expected or implied.
To prevent fake gifts, donors must show that the money really belongs to them, that they’re not funneling money back from a seller, builder, lender or broker. For instance, the U.S. Department of Housing and Urban Development requires under the Federal Housing Administration program that “regardless of when gift funds are made available to a borrower, the lender must be able to determine that the gift funds were not provided by an unacceptable source, and were the donor’s own funds,” for FHA-backed loans.
The reason lenders are so picky about gift letters and the source of donor funds is that they can face a huge penalty if they do not properly complete the loan application process.
Most mortgages today are originated by a lender – but actually, the “lender” might sell the loan as quickly as closing is completed. The loan is typically sold in the secondary market, lumped together with other loans, and then used to create a mortgage-backed security. Pieces of the mortgage-backed security are then sold to investors, such as pension funds, insurance companies and so-called “sovereign” funds. In effect, much of the money used to create mortgages actually comes from investors worldwide.
The catch for the originating lender is that it didn’t just sell a debt, it sold a debt that must meet certain standards. If the paperwork is not right, the originating lender can be forced to buy back the mortgage, which is why loan applications today require so many verifications.
Such buy-backs are not common, but they do happen and some lenders have been forced to repurchase loans worth billions of dollars just in the past year.
As a general rule, says the Department of Housing and Urban Development, the “FHA is not concerned with how a donor obtains gift funds, provided that the funds are not derived in any manner from a party to the sales transaction.”
In fact, donors can actually borrow the money, as long as the gift recipients are not responsible for repayment – think of parents who borrow money from a home equity line of credit to help a son or daughter buy property.
While the FHA has its rules, other loan programs can have different standards – for this reason, it’s important to find out exactly what lenders require when making a gift before looking for a property.
And if the answer you get back seems complicated and picky, just remember it’s the lender who may have to pay up if the gift paperwork is wrong.
Peter G. Miller is the author of “The Common-Sense Mortgage” and a veteran real estate columnist.