FHA allows for sellers to gift to the buyer part of the equity of the house that they are selling. This is called a gift of equity, but can only work between those that are relatives. This gift can be used for both the down payment and the closing costs. All other FHA guidelines apply to this type of purchase. ie. Credit qualifying and income.
Keeping in mind again that this can only be done amongst relatives.
How is this achieved? There are 2 ways for this to happen. And keep in mind that both the seller and buyer have to be a relative of each other.
1. The 85% rule which is the easiest and quickest. If I am the buyer, I could buy my sister's house but my loan amount can't exceed 85% of the value of the house. I would also be able to get the full 6% seller contribution from the seller. It doesn't matter if you show it as a 6% seller contribution or just as a gift of equity, it's all the same and coming from the same place. The bottom line is that it gets deducted from the seller's proceeds of the sale.
EXAMPLE
| Purchase Price of Home (sales price) | $100,000 |
| Maximum Mortgage Amount (x 85%) | $85,000 |
| Seller owes on current mortgage | $60,000 |
| Seller’s net profit/walk away after settlement | $25,000 |
| If seller was going to gift closing costs? (a) | $6,400 |
| Seller’s total net profit after closing costs paid (b) | $18,600 |
| | |
| Borrower’s total out of pocket monies | ZERO |
| | |
(a) This is just a basic example of what closing costs might be. They can drastically vary depending on the state and also on how many points the borrower wants to pay.
(b) There will still be added expenses from the seller. ie. Title insurance, closing fee, sewer, water, etc, etc.
***The seller does lose that equity which is the difference between the purchase price and the loan amount. Hence the reason why they call if a gift of equity. You are giving up that part of the equity that you had owned.***
2. The higher LTV (loan to value) rule. If the relative buying the so-called property also currently lives in the property, then they can go over the 85% threshold. The borrower would need a lease on the property and prove that they have lived there for 6 or months. This can be done by showing their driver's license, current utility bills, cable, etc, etc. Anything that can show 6 months of residence. And by doing this, the buyer will be able to utilize FHA's max financing programs.
Bonus : You can also have the seller co-sign for the borrower. Even though this person won't be living in the property. They can follow the normal non-occupant guidelines through FHA's financing. For these guidelines, please read : FHA -- Non-Occupant Co-Borrowers
DISCLAIMER : Make sure that you consult an accountant or reputable CPA on any type of gifts, may it be a gift or a gift of equity. Thanks to Bruce Bourgault for bringing this up.
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