What is a Gift of Equity?

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Buying a home is a huge investment, often the largest investment the average person makes in their lifetime. Homeownership itself is an expensive feat, yet still, it’s commonly lauded as part of the American dream. With a real estate market on the rise and a generation of people who barely make enough to cover rent, it's pretty easy to write off buying a home as nothing more than a pipe dream.

Of course, there are those fortunate enough to make it to the home buying stage, and officially become first-time home buyers. True, some inherit their family homes from parents or insanely rich aunts or uncles, but the majority of us simply don’t live in that particular fairy tale. For many of us, achieve enough stability to get a mortgage is typically a daunting, lengthy process. However, that’s not to say we can’t get some help along the way, either.

For a decent portion of first time and even repeat home buyers, it is not uncommon for a relative to chip in and “gift” some funding towards a home purchase. Gift money has helped a ton of people who simply could not save up the money to make a down payment turn a pipe dream into a miracle of a reality. Interestingly enough, there is a step beyond helping to fund a home purchase through gift money, and it’s almost like inheriting a home (you know, minus the whole “free of charge”, thing).

The “gift of equity” as it is called in the industry refers to when a homeowner sells their home, usually to a close family member, at a price well below the market value of the home. Typically, though not always, this type of home sale takes place well into the seller’s loan term, so they have quite a bit of equity accumulated for the property in question. The sale price is generally the remaining loan balance in such cases, which can be substantially lower than if the home buyer were to buy the home at full price.

What is the Gift of Equity?

Simply put, the gift of equity is when a homeowner sells their home at a significantly lower price than the home’s current market value. Gifts of equity are usually transactions between family members, typically from an older generation to a younger generation, like from parent to child, or grandparent to grandchild, etc. This kind of transaction is a lot more common than you would think and is a great way to keep a property in the family without breaking the bank for either party involved.

For the home buyer, they get to take out a mortgage on a much lower amount than the market value of the home. As far as lenders are concerned, the difference in value is seen as a kind of down payment. When all is said and done, the seller gets the final portion of their mortgage paid off, and the home buyer is left with monthly mortgage payments that are significantly more affordable than if they had purchased the home at full market value.

How to Give a Gift of Equity

While it may seem like the gift of equity is a complicated transaction to get through, it isn’t that much more complex than giving gift money towards a home purchase. As with the donation of gift money, it is all about having the appropriate documentation. As you can imagine, a “gift” of this proportion needs to be well documented in order to maintain legitimacy.

The first thing that a seller should do when giving an equity gift is to have their home appraised. A home appraisal is often conducted in the early stages of a home sale or home purchase anyway, but in this case, its importance is much more serious. In order for the value of the equity gift to be established, the seller needs to know what the house would sell for at the current market price.

Once the appraisal is completed, and the seller has an idea of how much the home is worth, then the process can really begin. The next step would be to determine how much they would like to sell the home for. When an amount is decided, that value is subtracted from the home’s appraised value.

The resulting figure represents the value or amount of equity that is being gifted to the home buyer. An important thing to keep in mind here is that the seller is allowed to gift any amount they choose. They are actually allowed to gift up to the full appraised value of the home!

As an example, let's say a seller gets a home appraisal that comes out to $300,000 even. They intend to sell the home to their eldest daughter for an incredible $100,000. This equates to a gift of $200,000 in equity. At that point, a portion of the equity gift can be put towards a down payment, and the daughter is still left with a super affordable mortgage of less than half of the home’s appraised value!

Of course, not all gift of equity transactions are as grandiose as the example above. The sellers, family or not, often need at least a little profit in order to be able to afford their next home. As such, a good portion of these “gift of equity” home sales involve values closer to 20% of the home’s value or, in other words, the value of the required down payment on the house.

Regardless of the amount being gifted, determining the precise amount of gifted equity isn’t where the process ends. In fact, the next part of the process is the most important when it comes to the legitimacy and completion of the actual sale. At this portion of the transaction, both seller and home buyer must get the appropriate paperwork in order. We can’t stress enough how important it is to have the right documentation.

Gift of Equity Letter

For starters, the seller will need to complete and sign a gift of equity letter. Just like the gift letters for gifting funds to home buyers, a gift of equity letter is the first piece of paperwork that shows the lender that the gift is not to be repaid by the home buyer at any point in time, or more simply, is not a loan of any kind. While there are gift of equity letter templates that can be downloaded online, an acceptable gift of equity letter should contain the following information:

  • Seller’s name

  • Seller’s address

  • Relationship to the home buyer

  • Home’s appraisal amount

  • Intended sale price

  • Gift of equity amount

  • Date of gift

  • A statement that clearly expresses that the amount is a gift, and no repayment is expected whatsoever.

  • Seller’s signature

  • Borrower’s signature

While the typical gift letter works in the case of gift money, these transactions require an added layer of security. Aside from the gift of equity letter, the transaction cannot be closed without a final confirmation from both parties in the form of a closing or “settlement” letter that clearly notes the gift for the transaction.

Things to Consider with a Gift of Equity

A  gift of equity may seem like the next best thing to inheriting a home (or leaving a home behind for your family if you are the seller). However, there are a few things to consider before going through with the process. After all, There is almost always a catch, isn’t there?

In the case of a gift of equity, one of the most important factors worth considering is the effect that the gift will have on taxes. You see, the home buyer may be faced with the upheaval of the asset’s cost basis, while the seller must be aware of the IRS’s gift tax exclusion limit and fill out any relevant paperwork in order for the gift to be legal. As far as the gift tax is concerned, anything over the current 2018-2019 limit of $15,000 must be declared and taxed.

Of less immediate concern to the parties directly involved is the fact that a gift-of-equity home sale may have a negative impact on the local real estate market. As it turns out, when a home sells for considerably less than its market value, appraisal values and sale prices of similar homes in the area typically fall. Even so, there are some cases where the transaction can be handled privately off the market to avoid these issues.

After all is said and done, a gift of equity is an amazing way for homeowners to extend the gift of homeownership to their family, who could probably use the help. Not every family can afford to leave an inheritance, but some can do a little more than cover a down payment with gift money. Regardless of the nature of the gift, or who it is going to or coming from, it is quite a welcome allowance in the home buying world, especially since it helps with what is typically the biggest investment a person will make in their lifetime.

If you plan to give a loved one the gift of equity and would like to learn more about the process or what to expect, then don’t hesitate to reach out and contact a home.loans mortgage specialist. Our experts are always standing by to provide you with all the information you need, completely risk-free!

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