Buying a Home With a Gift of Equity: How It Works and When It Can Help
Sometimes buying a home doesn't look like the traditional process of searching listings, competing with other buyers, and saving for years to build a down payment.
Maybe your parents own a home they no longer need and would rather sell it to you than put it on the market. Perhaps another eligible family member or approved donor under your loan program wants to help you become a homeowner by giving you a portion of the equity they have already built in the property.
In situations like these, a gift of equity may provide another way to structure the purchase.
A gift of equity allows an eligible seller to transfer a portion of their existing equity in the property to the buyer as a credit within the transaction. Depending on the loan program, property type, relationship between the buyer and seller, and structure of the purchase, that equity may be used toward some or all of the buyer's required down payment and certain eligible closing costs.
That means the seller may be able to provide significant financial help without first selling the property, receiving the proceeds, and then giving the buyer cash separately.
Imagine a parent owns a home and wants to sell it to their adult child. The parent has accumulated significant equity in the property and would like to use some of that equity to help their child purchase the home.
Instead of giving the buyer cash for the down payment, the transaction may be structured so that the seller provides an agreed-upon amount of their equity as a gift.
The seller isn't necessarily writing the buyer a check. Instead, they're giving up a portion of the proceeds they otherwise could have received from the sale, and that amount is documented as a gift of equity within the transaction.
This is what makes a gift of equity different from a traditional cash gift. With a cash gift, an eligible donor provides money that the buyer can use toward allowable home-purchase expenses. With a gift of equity, the value being gifted is already contained within the property being purchased.
One of the most common examples involves a parent selling a home to an adult child.
Perhaps the property has been in the family for years, the parents have built substantial equity, and they would rather help their child purchase the home than sell it on the open market. A properly structured gift of equity may allow them to use some of that existing equity to help with the purchase.
It can also be particularly helpful for a buyer who has sufficient income to comfortably afford the mortgage but hasn't accumulated enough cash for the down payment and closing costs associated with a traditional purchase.
Instead of the family needing to come up with additional cash, the resource they're using to help the buyer is already there. It's simply tied up in the property.
This is where a gift of equity can become especially powerful.
Depending on the loan program and transaction structure, gifted equity may be eligible to cover some or potentially all of the required down payment as well as certain allowable closing costs and prepaid expenses.
For example, imagine a family member owns a home with substantial equity and agrees to sell it to an eligible relative while providing a documented gift of equity as part of the transaction.
Rather than the buyer necessarily having to provide the entire required down payment from personal savings, the lender may be able to count the eligible gift of equity toward that requirement.
That does not automatically mean the buyer will purchase the home with no money out of pocket. Closing costs, prepaid taxes and insurance, reserves, and other requirements can still affect the amount the buyer needs.
It's also important to understand that gifts of equity cannot necessarily satisfy every financial requirement. For example, under Fannie Mae and Freddie Mac guidelines, a gift of equity cannot be used to satisfy required financial reserves.
Certain transactions may also have minimum borrower-contribution requirements.
This is why the loan program and transaction need to be reviewed before anyone assumes how much cash the buyer will need.
A gift of equity doesn't allow the buyer and seller to simply choose a property value for lending purposes.
The lender must establish an acceptable value for the home according to the requirements of the loan program being used. In many transactions, that will involve an appraisal, although certain conventional loans may be eligible for other approved valuation methods.
The established value matters because it can affect the loan-to-value calculation and how the transaction can ultimately be structured.
If the value used when planning the purchase is different from the value accepted by the lender, the original financing strategy may need to change.
This is another reason to involve the lender before the purchase agreement is finalized. A gift-of-equity transaction works best when the financing strategy, purchase contract and required documentation are aligned from the beginning.
A gift of equity can solve one important part of the homebuying equation, but it doesn't eliminate the normal mortgage approval process.
The buyer still has to qualify for the loan.
The lender will evaluate the buyer's income, credit, debts, employment, assets and other applicable underwriting requirements. The property must also satisfy the requirements of the mortgage program being used.
Think of the gift of equity as a way to help structure the funds needed for the purchase, not as a substitute for qualifying for the mortgage itself.
This is where the loan program becomes especially important.
Gift-of-equity rules are not identical across every mortgage program, and not every seller automatically qualifies as an acceptable donor.
For conventional financing, agency guidelines establish who may provide a gift of equity and the types of properties and transactions in which one can be used. FHA financing has its own requirements, including specific rules governing gifts of equity between family members.
The buyer's relationship to the seller, intended occupancy, property type and loan program can all affect whether the proposed gift is eligible.
Rather than assuming a gift of equity will work because the buyer and seller know each other or are related, the lender should confirm eligibility under the specific loan program before the transaction is structured.
Because a gift of equity involves the seller intentionally giving up part of their proceeds, the lender needs clear documentation showing exactly what is happening.
For conventional financing, this generally includes a gift letter identifying the donor, the amount of the gift, the relationship between the parties when applicable, and confirmation that the gift does not need to be repaid. The gift of equity must also be properly reflected on the settlement or Closing Disclosure.
Other loan programs may have their own documentation requirements.
The important thing is consistency. The purchase agreement, loan application, valuation, gift documentation and final closing documents should accurately reflect how the transaction has been structured.
This is why a gift of equity shouldn't be treated as something to figure out a few days before closing.
A gift of equity can also have tax implications, particularly for the person giving the equity.
Under federal tax rules, transferring property or an interest in property for less than full consideration may constitute a gift. Depending on the amount gifted and the seller's individual circumstances, a federal gift-tax return may need to be filed.
That does not necessarily mean the person providing the gift will owe gift tax.
The tax treatment can depend on factors such as the amount of the gift, available exclusions, previous gifts and the individual's overall estate and tax situation. A gift can also have implications for the recipient's tax basis in the property, which could matter when the home is eventually sold.
These are tax questions rather than mortgage questions, so both the buyer and seller should speak with a qualified tax professional when considering a significant gift of equity.
If you're considering purchasing a home from a family member or another eligible seller, this is one of those situations where talking with your lender before finalizing the purchase agreement can make a significant difference.
Your lender can review the relationship between the buyer and seller, determine whether a gift of equity is permitted under the proposed loan program, estimate how much equity may be available to use, identify applicable borrower-contribution or reserve requirements, and determine approximately how much cash the buyer may still need at closing.
That information can then help the buyer, seller, real estate professionals and appropriate tax or legal advisors structure the transaction correctly from the beginning.
A gift of equity can be an incredibly useful tool, but only when it is structured properly.
A family member doesn't necessarily have to hand you a large check to help you purchase a home.
Sometimes the opportunity is already sitting in the property itself.
When permitted under the applicable loan program, a gift of equity can allow an eligible seller to transfer a portion of the home's existing equity to the buyer as part of the purchase. That equity may help satisfy down-payment requirements and certain eligible closing costs, potentially reducing the amount of cash the buyer needs to bring to closing.
For the right buyer and seller, it can be an incredibly useful way to transfer a home within a family and help the next generation become homeowners.
But these transactions aren't something to piece together at the last minute. The relationship between the buyer and seller, property value, purchase price, loan program, amount of the gift and documentation all matter.
If you're thinking about purchasing a home from a family member, the best first step may not be writing the contract.
It may simply be sitting down with a lender and asking:
“Here's what we're trying to accomplish. What's the best way to structure it?”
This article is intended for general educational purposes and is not tax, legal or financial advice. Gift-of-equity eligibility and requirements vary by loan program and individual transaction. Buyers and sellers should consult the appropriate mortgage, legal and tax professionals regarding their specific circumstances.
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