Mortgage loans insured by the Federal Housing Administration, better known as FHA loans, are popular thanks to their low down payment requirements. But even though the down payments are lower, many buyers still struggle to come up with enough cash to cover them. FHA borrowers can receive help from their relatives -- or a seller who contributes to or runs an affordable housing program -- in the form of a gift of equity. The gift is used to cover the down payment for the borrower.
Down Payments, Closing Costs
FHA loans require borrowers to come up with a minimum down payment of 3.5 percent of a home's final purchase price. This is lower than the down payment requirements that come with conventional mortgage loans. But even a 3.5 percent down payment can be a struggle for some buyers. Consider that for a house costing $200,000, a 3.5 percent down payment would equal $7,000. FHA loans, though, allow borrowers to rely on gifts from family members and friends to help cover down payment and closing costs. One of the options that borrowers have is to accept a gift of equity credit.
Gift of Equity Credit
Borrowers receive a gift of equity when the owner of a house agrees to sell them that house at a price below its appraised value. A seller might sell a home that is worth $200,000 for $170,000. This gives the buyer instant equity of $30,000. That's more than enough to allow the buyer to cover the FHA's required down payment of 3.5 percent. The seller, then, has paid the down payment for the buyer by providing that buyer with this equity.
Borrowers and sellers must meet certain guidelines to participate in a gift-of-equity arrangement. First, the seller must be related to the buyer or must contribute to or run an affordable housing program. The U.S. Department of Housing and Urban Development, which runs the FHA loan program, must first approve a seller associated with an affordable housing program. The seller must also truly be giving a gift; sellers can't expect the buyers to ever repay them. Finally, the sellers must pay a gift tax if the gift of equity is $13,000 or more. Buyers will have to pay taxes on the gift of equity. It counts as taxable income.
Other FHA Gifts
The FHA also allows buyers to use cash gifts -- these can come from friends, relatives, co-workers or anyone -- to help cover closing costs or down payments. Again, the person making a cash gift must treat it as a gift, with no expectation that the buyers will repay the gift.