One of the most appealing features of FHA-insured mortgage loans is the small down payment requirement, which can be as low as 3.5%.
Some borrowers can cough up that money themselves from savings accounts and other approved sources, others however, may need to supplement their savings in other ways or they may need to ask parents to help out with the entire sum.
In this sense, the question of whether the FHA down payment can be gifted or not will come up often from borrowers who don’t have the required down payment saved up, but could make the down payment if the FHA accepts down payments that are gifted to borrowers.
The HUD Handbook 4000.1, the Single-Family Housing Policy Handbook, deals with this matter in terms of the source of the down payment, and offers guidelines in this respect.
In this article, I’m discussing the HUD’s take on gifted down payments, the acceptable sources of the down payment, and the conditions in which a down payment can be gifted.
Can Family or Friends Gift the FHA Down Payment?
Yes, the Department of Housing and Urban Development (HUD) that manages the FHA loan program allows borrowers to have their down payment entirely or partially gifted from parents, other family members, employers or other approved categories.
In 2019, the minimum down payment for an FHA loan is set at 3.5% of the home’s purchase value or appraised value, whichever is lowest.
The 3.5% down payment requirement is accompanied by a credit score requirement as well, meaning that only borrowers with a credit score of 580+ can qualify.
Other acceptable down payment sources include the checkings and savings account of the borrower, money saved up at home (“cash on hand”), retirement accounts, stocks and bonds, private savings club, etc.
Among other benefits, the low down payment requirement of the FHA loan program
is a major incentive for many first-time homeowners.
Although this loan system is designed for moderate to low income borrowers, it’s not limited to these categories of people.
Besides the low down payment requirement and the lower credit score expectations, another appealing feature of the FHA loan is the fact that the initial investment can be entirely gifted from an approved list of donors as defined by the HUD guidelines.
You can read the list of the approved donors in the HUD Handbook 4000.1 along with the other requirements of the gift.
The HUD Handbook 4000.1 lists the following approved donors who can provide the down payment gift to borrowers:
- Family members of the borrower;
- The employer or labor union of the borrower;
- Close friends with a “clearly defined and documented interest” in the borrower;
- Charitable organizations;
- Governmental agencies or public entities that have a homeownership assistance program designed for low to moderate income families and first-time homeowners.
Parties with an interest in the transaction, e.g. the seller, real estate agents, developers or builders, cannot contribute to the down payment, but they can contribute money toward the closing costs of the buyer.
The HUD uses a different wording stating that these interested parties may not contribute money toward the borrower’s minimum required investment.
Therefore, borrowers that don’t have money saved up for a down payment can receive the initial investment amount from any of the approved donors I listed above.
However, as you will see in the requirements of the gift I’m going to describe below, the gift must meet an important condition, namely that it cannot be a loan disguised as a gift.
Requirements of the Gift
Apart from the requirement that the down payment must be gifted to the borrower by approved donors as defined by the HUD, there are other requirements that must be met:
1. No Expectation of Repayment
A gift is defined by the policy handbook as “contributions of cash or equity with no expectation of repayment.”
This is an extremely important qualifying aspect of the contribution to the borrower’s initial investment, because this is how the HUD makes it clear that loans or gifts disguised as loans are not acceptable because they imply the “expectation of repayment.”
Therefore, if any of the approved donors offers the down payment sum to the borrower as a gift, they cannot do so with the expectation of repayment because that will be considered a loan, which is not acceptable based on the HUD guidelines.
This also means that a gift must be documented through a gift letter for it to be considered valid.
2. Gift Letter Requirement
The lender must obtain a gift letter from the person donating the down payment sum to the borrower, and the gift letter must meet the following minimum requirements:
- It must include the name, address and phone number of the donor;
- It must mention the relationship to the borrower;
- It must specify the amount of money being donated;
- It must include the statement that no repayment is expected.
It’s crucial to note that the gift letter must state in clear terms that repayment is not expected from the borrower.
If these requirements are met, the lender will further need to document the transfer of funds.
3. Documentation of the Transfer of Funds
In cases where the entire amount of the down payment or the partial amount is gifted, the HUD requires lenders to verify the transfer of funds prior to closing. This requirement is also laid down in the HUD Handbook 4000.1.
There are two different scenarios depending on whether the gifted funds have already been verified in the borrower’s account or not.
If the gifted funds have been verified, the mortgage lender should “obtain the donor’s bank statement showing the withdrawal and evidence of the deposit into the borrower’s account.”
In the absence of verification of the FHA down payment gift funds in the borrower’s account, the mortgage lender must obtain the certified check, money order, cashier’s check, wire transfer, or other official check, as well as the bank statement that documents the withdrawal from the donor’s account.
If the FHA down payment gift is not wired into the borrower’s account and it’s instead wired directly to the settlement agent, the lender must check that the agent has received the gifted amount from the donor.
In the above scenario, the mortgage lender must also verify the source of the donation, namely that it’s coming from approved donors as defined by the HUD.
In the absence of bank documentation or savings accounts, the mortgage lender must obtain written evidence from the donor that the amount comes from an acceptable source and not a party to the transaction.
Therefore, the HUD is very specific about where the funds can come from and the nature of the funds, namely that they must constitute a gift and not a loan.
Regardless of the approved source of the down payment (savings accounts, stocks and bonds, retirement funds, etc.), the lender must verify and document its source.
A Note on Cash On Hand Down Payment Sources
While around 25% of borrowers use gift funds from family or relative to make their FHA down payment, an interesting source of down payment approved by the HUD is cash on hand.
Cash on hand is defined by the handbook as cash “held by the Borrower outside of a financial institution.”
Unlike the other acceptable sources of down payment, which are easy to document, cash on hand is a bit more difficult to document.
However, this source too, as any other down payment source, is subject to verification based on the guidelines offered by the HUD.
According to those guidelines, the mortgage lender must verify the cash on hand by requesting a written explanation from the borrower that should include details on how the funds were accumulated as well as the time it took to accumulate them.
Furthermore, the lender should determine whether it’s reasonable to accumulate these funds in the given amount of time.
To make this determination, the mortgage lender must examine the income and expenses, the spending history of the borrower, and must look at their banking history.
If the lender is satisfied with their examination and determines that the funds were reasonably accumulated over the timeline provided by the borrower, it will accept the funds as down payment.
Since all sources of the down payment must go through a verification process, so does any money that’s saved up at home by the borrower that’s going towards the down payment.
FHA loans have a low down payment requirement designed to provide moderate to low income borrowers a suitable option to finance a home.
The minimum down payment of 3.5% can come from the borrower’s savings or it can be gifted by parents, relatives, close friends, charities, etc.
However, the gift must be offered to the borrower without an expectation of repayment, otherwise it constitutes a loan.
Moreover, the gift must be accompanied by a gift letter and the receipt of the gifted funds by the borrower must be documented by the lender.