Mortgage gifts and loans from family: Advantages and the tax rules around it

Mortgage loans are one of the biggest loans a person takes in their life. Real estate is bought so that we may have a permanent place to live and beat the cost of renting and residence eventually. It is a major step towards financial independence and self-reliance. Most of us start thinking of buying a home as soon as we know we are willing to stay in one place at least for a few years and need to have our money go further towards a living space.

Home prices are generally high so that they are unaffordable 10 years into our career. For this reason, the majority of us shop for a mortgage so that we can purchase a home early on and pay towards it as life progresses.

Mortgages generally have two components: the down payment as well as the loan. Down payment is a sum of money you want to put towards the mortgage to show that you have some financial worth and earning potential and can show the lender that you may be capable of paying off your loan in the future with this demonstrated earning potential. The loan component is what the lender lends you towards the purchase of your home and this is generally secured against the home. ‘Secured’ means that if you default on your loan, the lender can then acquire or own the home instead of you, and you will lose ownership of the home.

When you approach a mortgage lender, they will generally ask for you to put 10%-20% down towards your home purchase at the very least. They also will ask to see your bank statements for the last few months to see steadiness in your income deposits and also any anomalies of one-time payments in the bank.

What is a mortgage gift?

Since home purchase is considered a step up in life, family and friends generally help their loved ones by giving them money towards such a stepping stone. You can receive a gift of money towards the purchase of your home at any time (e.g. when you get married) that you can use when you are ready (e.g. maybe a few years after marriage), but most people actually receive the funds when they have already started shopping towards a home. This is when family or friends are willing to give you money since you know you are now ready to buy a home.

Such a gift of money is generally given towards the purchase of your home without expecting payback.

Why do mortgage lenders need a gift letter documented?

When you mention such a gift to a lender or they see a lump sum transaction in your bank which may be this, lenders require such a note since it clearly states that this is not a loan. The reason is this: Any loans you are obligated to, get counted as debt and when lenders evaluate your credibility to be able to payback a loan your debt/income ratio needs to be 35% or lower to be able to prove that you will be safely reliable in paying back your loan. (Note: This ratio varies per lender and type of loan).

What information does the mortgage gift letter need to have?

It needs to have details about both the giver, donor and the property towards which the mortgage gift is being given. Namma's gift letter generator workflow asks you for the required details and fills in the details for you.

Any money given towards a mortgage gift will have to follow IRS gift tax rules. Tax gift limits are $16K for the year 2022 per donor to taker (this means, a married couple can together gift a child $32K), as per the IRS and an amount up to that does not get taxed. Please look through IRS form 709 and its instructions to understand gift tax rules and how they may change or apply each year. Any gift amount above that eats into the lifetime gift exemption amount and if that limit has been crossed, may trigger the gift tax.

The donor pays the gift tax (when amount exceeds limits), unless the recipient opts to do so, in case it has caused the donor to go beyond their lifetime gift tax limit.

Who can give a mortgage gift to you towards the purchase of your home?

For a conventional mortgage, a gift can be given to you by a blood relative (e.g. parents, sibling, uncles, aunts) or a spouse. For FHA and VA loans, these restrictions are more relaxed and gifts can be made by other people in your network as long as they are not an interested party in your home purchase transaction.

How do I get a mortgage loan towards my home purchase from family or friends?

Bypassing the mortgage lender for purchase of a home can be a very financially savvy move. Do you have family and friends who would be willing to lend you money towards a mortgage and receive monthly payments back just the way a bank does? In this case they might have a lot to gain. After all, the interest that you pay a lender over the lifetime of a loan really does add up (e.g. a $300K loan over a span of 30 years with 3% interest generates $155K in interest alone). A family member or friend might gain immensely from such a loan if you are a credible borrower.

In this case we recommend you use our loan flow to request a loan from people you know. We help you document the loan in an e-signed contract such that you are legally liable to them for the loan and help you generate an amortized schedule that can be tracked over time.

Disclaimer: Namma is not your legal advisor, tax advisor or lawyer. Our blogs are based on product research done by our team with our customers and our service is meant to make borrowing and lending between family and friends less awkward and more uplifting.

Sources used for this article:

Fannie May - B3-4.3-04, Personal Gifts (12/14/2022)

IRS - Instructions for Form 709 (2022) | Internal Revenue Service

HUD.Gov - Section B. Acceptable Sources of Borrower Funds Overview