Before giving money for a down payment, consider the tax implications and paperwork requirements.
Buyers looking to snatch up property before prices and interest rates rise throughout the country may look to relatives for help. According to the National Association of Realtors 2012 Profile of Home Buyers and Sellers, 14 percent of all homebuyers and 24 percent of all first-time buyers received a gift to help them cover a down payment. The fact that it's a gift doesn't affect a borrower's interest rate; however, the borrower must still demonstrate adequate income to qualify for a mortgage.
"There's a tremendous amount of wealth being transferred from one generation to the next," says Marc List, a managing director at the national accounting firm CBIZ MHM. "It's natural for parents to want to help their children, and education and home purchases are probably the most common areas."
Mortgage lenders typically allow gifts from relatives on down payments for an owner-occupied residence – not an investment property – but a gifted down payment typically involves extra paperwork. Michael Rosenbaum, a mortgage loan originator with First California Mortgage Company in San Diego, says he often asks for bank statements from borrowers planning to use a monetary gift. "To comply with the Patriot Act and make sure it's not drug money or terrorist money, we're going to need a copy of bank statements and the wire transfer," he says.
When relatives (often parents) are reluctant to share bank statements with the gift recipient, Rosenbaum will sometimes have the gift giver transmit statements directly to him with the understanding that they won't be shared with the borrower. "Mom and Dad are happy to give a gift, they just don't want to show their bank statement," he says.
Ben Nettleton and his wife ran into these paperwork headaches when they bought a home in Houston earlier this year, and Nettleton's mother-in-law gave the newlyweds cash for part of the down payment as a belated wedding gift. Because they received the gift about a month before closing, Nettleton's mortgage lender requested a statement from his mother-in-law to ensure it was a gift and it wouldn't cause financial distress. "I thought this is kind of silly to have to do all this extra stuff we wouldn't have had to if she'd just given it the month
or two before," Nettleton says.
One way to avoid this extra step is to "season" the funds by transferring them ahead of time. "The typical method to do that is to get the funds and let them sit awhile," Rosenbaum says. The precise timing depends on when the borrower's bank statements close, but most mortgage lenders will want to see two complete months of bank statements. Money deposited prior to those two months would be seasoned enough not to be scrutinized as a gift.
In addition to documenting gifts for mortgage underwriting purposes, gift givers and recipients should consider the potential tax implications. Under the Internal Revenue Service's annual gift tax exclusion, one person can give up to $14,000 to another person in 2013 without triggering a gift tax.
However, there are ways to get around the tax. For instance, two parents could give up to $56,000 to a child and the child's spouse by making four separate gifts of $14,000. "The easiest way to accomplish this is to write four individual checks," List says. "If one parent writes a check for $28,000, then the two parents have to file a gift tax return and agree to split the gift." If parents want to gift more than $56,000, they could choose to file a gift tax return and count that money toward the lifetime exclusion of $5.25 million per gift giver.
List says parents should keep in mind that once the gift is given, it's permanent. As he explains, "It puts $56,000 in the children's hands to make a purchase on a house, and there's no control left on the asset because a gift is irrevocable."
One alternative to gifting money is to make a loan to a recipient so it would be repaid in case a couple divorces (a down payment becomes a commingled asset when it's used to buy a home). "A lot of times, parents prefer not to make gifts upfront," List says. "They want to make sure the marriage works first." While the loan is in place, the relative would need to charge interest but could later forgive the loan and make it a gift. In a family loan scenario, mortgage lenders would typically want assurance that the loan is subordinate to the mortgage, meaning the bank is repaid before the relatives.