A gift of equity is an exchange of real estate between someone who seeks to purchase a home and—in most cases—a family member.
Usually, the family member or relative will take a reduction in sales proceeds to offer the buyer an equity position in the home, which acts as the down payment amount.
If you have recently been offered a gift of equity, you might have a handful of questions, such as:
- What is a gift of equity?
- What’s the process?
- Who can give a gift of equity?
- How do I accept a gift of equity?
- What are the benefits?
- Are there any drawbacks?
We have the answers to these questions and more. Read on!
What is a gift of equity?
A gift of equity references any gift from a property seller to a buyer. The seller is classified as a family member, relative, or acceptable donor.
Let’s define two key terms that play a role:
- Appraised value—also known as a property valuation—is the assigned value of a real estate property determined by a real estate appraiser.
- The gift of equity is the part of the seller’s equity in the property that is given to the buyer as a credit within the transaction.
You might be wondering why you receive immediate equity in the home. Since real estate is an asset you can sell for value, equity for the house has been built over time, as the homeowner pays the mortgage.
For example, when you lease a car or rent a house, once the lease is up, you have to turn it in—with no value back in return. But when you buy a house, you can turn around and sell it for proceeds.
When a seller gives a gift of equity to the buyer, they are selling the home at a price below the appraised value—and that difference can serve as the down payment for the buyer.
That’s how the “gift” plays into a gift of equity.
Who are acceptable gift of equity donors?
Who is able to provide a gift of equity?
Acceptable donors qualify if they are:
- A relative, meaning the borrower’s spouse, child, or other dependent.
- Any other person who is related to the borrower through marriage, adoption, blood, or legal guardianship.
- A domestic partner or fiancé of the borrower.
What steps need to be taken to obtain a gift of equity?
Once you are offered a gift of equity, there are a few steps that you and the seller need to take to complete the transaction.
Steps for the Seller
The seller will need to take three important steps:
- Draft a purchase & sale agreement: Specific language and structuring needs to be included with the gift of equity in a purchase and sale agreement, so consult an attorney and communicate with a mortgage lender. This document includes the appraisal price and the sale price.
- Sign a gift letter: A gift letter is a document that provides all necessary information about the gift, including the amount being provided. Both the seller and buyer are required to sign the letter. Keep in mind that this letter is an agreement of terms, not official closing documentation. The lender will produce the gift letter for both parties to sign.
- No official appraisal is needed from the seller: For the buyer to receive a loan, they need to work with a lender. The lender will work with an appraiser to determine the home’s value as the lender cannot use the appraisal that was done for the seller.
Steps for the Buyer
The buyer will need to take the next step in the home-buying process:
Apply for a mortgage: In most cases, the gift of equity does not cover the entire cost of the home. This means that the buyer will need to undergo a process similar to buyers who do not have a gift of equity. Once you contact a lender, you will begin the lending process and provide your credit score, proof of income, proof of assets, and other important documents.
What are the pros and cons of a gift of equity?
You might be thinking: This seems like a great deal, but what’s the catch?
A gift of equity can be highly advantageous, but there are a few things to consider before you decide to go through with the deal.
The Pros of a Gift of Equity
- The seller—usually a family member of the buyer—plays a significant role in growing the buyer’s wealth.
- The buyer receives a portion of equity (an asset) as a gift.
- The buyer does not need to purchase mortgage insurance if the gift of equity is large enough.
- The gift of equity can be used as a down payment and go toward closing costs.
- The buyer does not need to pay gift taxes on the gift of equity.
The Cons of a Gift of Equity
- The seller receives less proceeds in the sale of their home.
The sellers may have to pay a gift tax if the price of the gift is above a certain amount.*
Get gift of equity guidance from a Loan Officer.
A gift of equity can be a highly beneficial transaction that provides you with a home at an affordable price and a leg up in growing your wealth.
As you’ve read, writing the gift of equity letter, understanding tax implications, and following other rules all require expert assistance from a professional who understands the terrain. The Loan Officers at radius are here to guide you through the process.
Want to learn more about purchasing a home for the first time? Take a look at our guide, Home Buying 101.
*Please note: It is important to consult a tax professional for tax advice.