Table of Contents
- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
About Gift of Equity
When you are looking to buy a new home, as a borrower you need to make sure that you have enough funds to pay for the down payment based on the type of mortgage you choose to get.
However, there is an option where you can save this down payment if you are buying the property from your family member or a seller with a close relationship.
This term is called a gift of equity and in this post; we will learn what is gifted equity in detail.
What Is Gift Of Equity?
A gift of equity is the sale of real estate to the seller’s family member or close associates at a price below its actual market value as per the conducted appraisal.
The difference between the actual sale price and the market value of the home is known as the effective gift of equity.
Most lenders and banks use this equity contribution to be part of the down payment.
It is a seller’s way of helping a buyer, usually a family member to buy a home. In this type of gift, there is no involvement of actual cash, unlike a down payment gift.
In return, they agree to sell the home below market value and help the buyer with more equity instantly.
How Does Gift Of Equity Work?
A gift letter signed by the seller is required to earn an award for this type of gift. This letter will include your home address and the amount of the equity that will be provided by the seller as a gift.
The letter must also describe the relationship between the seller and the buyer and include a statement that they say this is a gift for which the buyer is not obligated to repay.
The seller is required to hire an appraiser to determine the current property value in the market.
This indicates the exact amount of equity that is being gifted to the buyer. If the property is appraised at $200,000 and the seller sells it for $150,000, the actual equity that is being gifted would be $50,000.
As a borrower, even if they are receiving equity as a gift the process of property purchase remains standard.
The buyer will still need to go through the process of acquiring a mortgage if the equity contribution given by the seller does not cover the entire price of the property.
For example, if the property for $200,000 is sold for $150,000, the buyer needs to apply for a mortgage for $150,000. As the buyer applies for a mortgage, the lender would be required to follow the traditional qualifying process including a credit check and income verification.
For a lender to qualify the buyers, they must provide copies of the last 2 years of pay stubs, the last 2 years of tax returns, the last 2 months of bank statements, and the last 2 years of W-2 forms, with identification documents.
Buyers must also allow lenders to check their credit reports and FICO scores.
Who Has To Pay The Gift Of Equity Tax?
The sellers need to be aware of the tax implication when they are giving equity contributions to the buyer.
According to the IRS rules, each individual can provide up to $15,000 to other individuals in gifts every year including both cash and equity contribution.
This means if a couple wants to gift equity to their child; both can give the equity contribution of $30,000 without filing for tax for that year.
What Are Gift Of Equity Pros And Cons?
Pros:
- No Taxes are to be paid by the buyers for the amount of equity gifted by the seller.
- No actual cash transaction is involved.
- This equity contribution helps the buyer to make less or no down payment.
- Buyers are not required to pay PMI if the gifted equity is more than 20% of the property value.
Cons:
- If the gifted equity is more than the limit set by the IRS, the seller would have to file for gift taxes.
- Since the property is not sold at its actual market value, sellers lose out on an opportunity to gain profits by gifting equity.
Conclusion
With the help of the gift of equity option, the buyer can save a good amount of money and get into homeownership. Reduction in the sales price helps the buyer to get a lower or no down payment.
Having enough money saved along with this gift of equity will help you to get lower monthly payments and save money.
As a seller, you might want to check your gifting limit before you process this type of transaction.
