What Is a Gift of Equity?
Typically buying a home involves the most significant investment that ordinary people often make in their lives. Homeownership is an expensive dream for anyone with average earnings. On top of that, the real estate market keeps growing each year, making it very difficult for people who barely cover their rents to even think of becoming homeowners. Home for these people has become far beyond their reach.
Then are those fortunate people who, after years of savings, make it to the home-buying phase, and finally, become first-time home buyers.
For all those who dream of having a home sometime in their lives, the “Gift of Equity” falls as a blessing.
What Exactly Is a Gift of Equity?
The gift of equity refers to when a homeowner sells their home, usually to a close family member, at a price much below the home’s original market value. And the difference between the house’s actual cost and the price at which it’s sold is known as a gift of equity. It is commonly seen that a lot of lenders allow the equity to be used toward a down payment.
How Does a Gift of Equity Work?
The most commonly seen gift of equity is when parents wish to sell their home to a child for a low price. As already mentioned, most lenders count the gift as a down payment on the house. The residence that the lender wishes to sell could be either their primary or a second home.
The best advantage that the gift of equity offers is that it helps the buyer reduce or even eliminate down payment requirements, which makes it much easier for the recipient to secure a home loan.
- Your relative’s home has a value of $500,000 per verified appraisal
- They want to sell that to you for $400,000
- You are offered $100,000 in equity, which is 20% in home equity instantly
- You take out a home loan of $400,000
Now, let’s suppose that your relatives wish to move out of their residence to another place and desire to downsize. They’ve always wanted to give that old home to you, but the new home that they want to move into is out of their price range, at least from a down payment perspective. So in this scenario, they don’t just merely hand over the keys to you; they offer you the gift of equity by selling it for a lower-than-market price.
According to the appraisal, the home is worth $500,000 at the present moment, but your relatives are offering you $100,000 in gifted equity. Therefore, the home is being sold for $400,000, meaning your relatives will walk away with the lower proceeds once the loan funds. But because the property appraises for $500,000 you can take out a loan of $400,000 and instantly acquire 20% equity.
The loan would be priced at 80% LTV, low enough to avoid any mortgage insurance. And this will also aid you in acquiring a more competitive mortgage rate. This creates a win-win situation for all the parties involved and helps you to resolve the down payment hurdle.
To acquire a gift of equity, there are specific rules that one must follow. The first requirement is writing the gift of equity letter, which is signed by the seller and buyer. The letter states the fact of the agreement and is signed by both the seller and the buyer. Along with an equity letter, other things that are required include:
- The seller must officially complete the paid appraisal on the home.
- The relationship between the buyer and the seller must be disclosed in the loan file.
- The gift of equity can be utilized on a primary residence or second home but not on investment properties.
- The appraisal must include the price of equity for which the home will sell for.
People Also Ask:
Is a gift of equity a good idea?
A gift of equity alleviates the burden of a 20% down payment on your child, which would otherwise take several years. By paying the full 20%, they are also saved from the additional PMI Fees on each mortgage payment.
Can you do a gift of equity on a conventional loan?
Yes, you can do a gift of equity on a conventional loan since conventional loans allow that. But one can only acquire the gift of equity if the seller of the property sells to one of his family members. Anyone could easily open a conventional loan for only $80,000 to buy the property. And this 20% in gift equity would count as your down payment.
How much equity can you borrow from your home?
Generally, anyone can easily borrow up to 80% of their home’s value in total. So, he or she may need more than 20% equity to take advantage of a home equity loan.
What is the difference between equity and down payment?
Equity refers to the remaining amount of the property’s total price, which is not covered by the loanable amount. Whereas both the seller and the buyer usually calculate down payment to finalize the purchase.
To the majority of people, a gift of equity looks like the next best thing to inheriting a home. But it is, however, important to consider a few things before going through the process.
One of the most critical factors that one must not neglect is the effect of a gift of equity on taxes. It is important to note that anything over the current 2018-2019 limit of $15,000 must be declared and taxed.
Priority Lending, LLC has been providing mortgage loans and helping people like you fulfill their dreams since 1997. Contact one of our loan officers today to get started on refinancing your mortgage.
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