How Does the Gift of Equity Work?
A family home can hold a lot of history — first steps, first days of school, anniversaries, family reunions, and more. When it’s time to sell your home, it can be hard to hand over the keys to total strangers. Have you ever thought of selling your family home to your child? Giving the gift of equity offers benefits beyond keeping your home in the family. When you sell your home to a child or other family member below market value, you are also providing them with down payment assistance and the opportunity to afford a home or neighborhood they couldn’t swing on their own.
Giving the Gift of Equity
So, how does the gift of equity work? In a gift of equity scenario, a home is sold below the current market value, and the difference between the actual sales price and the appraised value of the home represents the amount of equity. This is considered a present because there is no expectation that the difference will ever be repaid. In most cases, the recipient will use the gift of equity amount as a down payment on the home.
In most cases, a gift of equity home can be sold to a child, grandchild, niece/nephew, spouse, or domestic partner.
When selling your home to a family member, a home appraisal is still necessary. Lenders typically do not approve loans for a home sold for significantly less than its value, so special steps must be taken:
• The seller must arrange for an official appraisal of the home.
• The paperwork must include the appraised value of the home, the price the home will sell for, and difference between the two.
Gift of Equity Down Payment
In most cases, a gift of equity can be turned around and used as a down payment on the home. Let use this example: Your home is valued at $215,000 and you plan to sell it to your child for $190,000. So the gift of equity you are giving is $25,000* (or 12% of the home value). If a lender requires a 20% down payment, your child can use the gift of equity to cover 12% and only needs to pay an additional 8% on their own.
*IRS guidelines on monetary gifts cap amounts at $28,000 per couple and $14,000 per individual.
A gift of equity down payment alleviates the burden on your child to save a full 20% down payment, which could take years. Additionally, by paying the full 20%, they also avoid the need to pay an additional PMI fee on each mortgage payment.
In the event that the property is worth more than the needed sales price, the lender may not require the additional value be included as part of the documented gift amount. Typically, only the amount needed to complete the transaction is documented. Although, if you have any concerns about tax implications, you should check with your tax advisor.
In addition to this gift, you may also provide a seller’s assist and cover the closing costs necessary for the sale of your home. Again, this relieves your child from the burden of a large upfront payment.
Gift of Equity Mortgage
When applying for a mortgage on a home that is being sold with a gift of equity, you and your child will need to create a gift letter that outlines the following:
- Amount of the gift
- Date the gift was/will be given
- No repayment is expected
- Seller’s name, address, and relationship to the buyer
Additionally, the gift of equity must be clearly stated on the appropriate closing documents.
Beyond these two requirements, the remainder of the mortgage process will proceed as usual. The buyer can apply for any type of mortgage, including a fixed rate or adjustable rate loan, a 30-year or 15-year loan, or a FHA or VA loan. The loan approval and closing procedures will also be executed as normal.
Gift of Equity Tax Implications
As mentioned above, the IRS does put a limit on the amount of monetary gifts a parent can give to a child. If your gift of equity exceeds the allowed amount (28,000 as a couple or $14,000 as an individual), you will need to declare the overage on your tax forms. This doesn’t necessarily mean you’ll have to pay taxes on this amount, but it could affect your lifetime gift contributions, which are also tracked by the IRS.
“When trying to decide how to figure out the numbers, don’t be afraid to reach out to your mortgage lender and ask them to help you,” says Ben Huard, Sr. Real Estate Originator at Diamond Credit Union. “I’ve often times met with families, not only to make sure the seller gets what they need from the sale of the home, but also to ensure that the buyers can minimize the tax implications and keep the amount needed at settlement as low as possible.”