Gift letters involve the provision of money to borrowers to enable them to make a down payment. A gift letter is generally referred to in terms of a mortgage. If you are buying a home, but lack the cash to make the required down payment, then a gift letter can be used to legally offer the cash.
The reason for gift letters rather than just straight loans is than mortgage lenders do not like mortgage applicants borrowing cash to make their down payment. If analysis of the mortgage applicant’s financial circumstances shows them that he or she has no cash reserve to make the down payment, then the mortgage will usually be refused.
Background to Gift Letters
When you apply for your first mortgage, you have to provide copies of your bank statements and any other forms of investment to back up your application. It can become apparent then that you do not have the wherewithal to make the deposit. This will likely be 20% of the selling price or thereabouts.
It is next to impossible to hide the fact that you do not have 20% of a $400,000 dollar home to pay as a deposit. $80,000 is a lot of money to hide. Should you suddenly come up with this amount of cash the lender will want to know where you got it. Their worry will be that it might come from a loan to another party, and that this loan will not only have to be repaid, but might also be your first priority- after your mortgage loan.
That’s why you are not usually allowed to borrow your deposit! It is not impossible, but most lenders will be reluctant to allow it. A gift, on the other hand, is permitted – assuming you can prove it to be a gift and not a ‘hidden’ loan for your down payment. Here is how gift letters work.
Mortgage Gift Letter Basics
If a friend or relative is willing to make you a gift of your mortgage down payment, he or she must write a gift letter. Gift letters are necessary anytime cash is provided to a borrower to make a deposit or down payment that they would otherwise not have been able to pay.
The letter should state the amount of cash being gifted – that’s obvious! What is more important, however, is that all gift letters should state that money being gifted is not expected to be repaid in any form. That includes repayment in cash, services, free work, gifts in return or any other means of repaying a gift.
The non-repayment statement is essential if the gift is to acceptable as a mortgage deposit. The letter must be made in writing and signed by the giver, and not just as an email. If the person providing the gift is a relative, then that should also be stated. This will not prevent the gift being allowed.
Mortgage Down Payment Gift Procedure
The procedure to follow is for the body making the gift to write to the mortgage lender. They should state the amount of the gift and what it is for – to pay your deposit. They should also state that they do not expect to be repaid – it is a gift to you, pure and simple. Such payments must have been made and verified before you can complete the purchase.
The gifter must state where the cash is coming from (bank account, investments, etc.) This might be checked to make sure that there is no collusion between the gifter, borrower and realtor to facilitate the purchase.
Gift letters can be very useful for mortgage borrowers that have relatives able to make their down payment. For them to be legal, they must be true gifts and not repayable. For many, particularly in an era where 20% down payments are being asked, this is the only way for young first-time buyers to be able to own their own homes. Compare that to the old days when all you needed was to hammer a stake in the ground and build your own Ponderosa (hence ‘stake your claim!).