If you are thinking of purchasing a home from a family member or a relative, a gift of equity can help you with the down payment.
Usually gifting rules still apply on "gifts of equity", meaning if the total gift of equity is less than 20% the borrower may still have to come up with a 5% down payment from their own resources.
Be aware that there are potential tax consequences for gifts of equity. You should discuss the particulars with a tax advisor or qualified accountant to understand how it can impact you specifically.
A good rule of thumb in looking at if a gift tax is going to be paid is the following: each person is allowed to gift any other person $12,000 per year with out disclosure to the IRS. So for parents giving a gift of equity to a child, then each parent can gift $12,000 for a total of $24,000 to that child. Anything beyond that is taken from a $1,000,000 (one million dollar) gift tax exemption over the life of the giving individual.
Example: You have a person buying his/her childhood home. The home is worth $250,000. The parents want to gift $50,000 to the person so the buyer only has to get an 80% loan. Each parent is gifting $25,000. The yearly $12,000 kicks in so $13,000 is deducted from the $1,000,000 gift tax exemption. Therefore each parent can still give that child up to $999,987.00 in gifts over the rest of their lives.
The lender will normally require a signed letter with the transaction details included on it.
In this transaction, the sales price is typically the appraised value of the home. The lender funds part of that sales price (usually what is owed on the property), and the remainder is considered a "gift" from the seller to the buyer.
Within the signed letter, or purchase contract, the seller may agree to pay for the buyer's closing costs, resulting in little or zero out-of-pocket expenses for the buyer.
Under FHA guidelines, as little as a 3% gift of equity will suffice for the down payment to purchase a property.
A gift of equity is when someone other than the borrower provides money that is used for a down payment. Lenders want the details of the gift because if it is in actuality a loan and not a gift, it may affect the borrowers ability to repay the lender.
Another example regarding the purchase of the $200,000 home would this. Lenders will accept a parent’s gift of equity of $50,000 as the equivalent of a cash down payment, provided that they are satisfied that the house is really worth $200,000.
Depending on the number of children you have and whether you are single or married, you may be able to avoid a substantial percentage of gift tax, and even taxable gifts may be allowed without paying tax. See IRS form 709