How does a gift of equity work? Gift of equity rules and limits

What is a gift of equity?

A gift of equity occurs when the home seller agrees on a price significantly lower than the home’s appraised value. The difference between the property value and the sale price is the “gift.” This helps cover the buyer’s down payment.

Gifts of equity typically happen when the seller has a personal connection to the buyer and wants to help them out; for instance, when a parent sells a house to their child.

Here’s what you need to know to make this arrangement work.

In this article (Skip to...)

• How it works
• Equity gift vs. cash gift
• Who can give a gift of equity?
• Gift of equity rules
• Gift of equity limits
• How it affects buyers
• How it affects sellers
• Tax implications

How a gift of equity works

When a seller gives a gift of equity, they agree to sell their home for less than it’s worth. This leaves an equity cushion in the home, which acts as the buyer’s down payment.

For example, say you’re buying a home from your parents. The home is worth $400,000, but your parents agree to sell it to you for $300,000. This creates a $100,000 gift of equity — equivalent to making a $100,000 (25%) down payment on the home.

A gift of equity has many benefits. It can help buyers who aren’t able to save for a down payment on their own. And, by lowering the loan amount, it could remove private mortgage insurance (PMI) or lower the buyer’s monthly mortgage payments.

Keep in mind that if you use a mortgage to cover the rest of the purchase price, you’ll have to follow your lender’s rules regarding gifts of equity.

Gift of equity vs. down payment gift

This article is about a gift of equity rather than a cash down payment gift.

What’s the difference? A gift of equity involves the home seller. It requires them to agree on a below-market purchase price in order to “gift” their equity to the buyer for a down payment.

A cash down payment gift, on the other hand, does not involve the seller. In fact, the seller is not allowed to give a cash down payment gift. Rather, this is money gifted by a family member or close relation of the buyer who wants to help them afford a home.

If you’re looking for information on cash down payment gifts, you should read this article instead. If your situation involves a true gift of equity, read on.

Who can give a gift of equity?

Obviously, there aren’t many (if any) sellers who would give gifts to total strangers. So a gift of equity almost always occurs within families.

Indeed, for a gift of equity on an FHA loan, the Federal Housing Administration says: “Only family members may provide equity credit as a gift on property being sold to other family members.”

Other lenders and loan programs may be more lenient. For example, Fannie Mae (one of the agencies that regulate conventional loans) says gifts of equity can occur between:

• The borrower’s spouse, child, other dependents
• A fiancé, fiancée, or domestic partner
• Any other individual who is related to the borrower by blood, marriage, adoption, or legal guardianship

If you don’t want a loan guaranteed by the federal government, Fannie Mae, or Freddie Mac, you may be able to find a lender that will allow a gift of equity from someone who isn’t a family member or closely related.

Gift of equity rules

To be eligible for a gift of equity, the buyer and seller both have to meet the mortgage lender’s requirements.

As explained above, the buyer and seller need to have an eligible relationship (these transactions typically happen within families). And, importantly, the seller must certify that the gift of equity is a true gift and not a disguised loan that will have to be repaid.

All such gifts require a letter from the seller setting out the arrangement. The gift of equity letter must include:

• The seller’s name, address, and phone number
• The value of the gift (a dollar amount)
• The nature of the relationship between the buyer and seller
• A clear statement that no repayment of the gift funds is ever required

You may be able to find templates for these letters online. Beyond that, rules vary by type of mortgage and from lender to lender.

Government-backed loans

FHA allows gifts of equity as long as the home is being sold from one family member to another. VA and USDA loans don’t require a down payment, so equity gifts are rare.

The USDA says, “The gift of equity must be expressed as a reduction to the sales price,” meaning you cannot receive cash-back closing.

We scoured the VA website but could not find references to equity gifts. If you’re using a VA loan, check with your lender to see whether it allows equity gifts and what the rules are.

Conforming loans

Fannie Mae allows gifts of equity as long as the buyer and seller are related by blood, marriage, or legal guardianship. In addition, the home being purchased must be the borrower’s primary or second home; no rentals or investment properties are allowed.

Fannie also says the gift of equity can be used to pay the borrower’s upfront closing costs as well as their down payment.

Freddie Mac says, " ... a gift of equity is an eligible source of funds for a Mortgage secured by a Primary Residence or second home provided ... the funds are from a Related Person.”

However, Freddie specifies that if your down payment is over 20%, at least 5% must come from “the borrower’s personal funds.” And gifts cannot be used when buying an investment property.

Other conventional mortgages

If you don’t want a mortgage that’s backed by the government or that conforms with Fannie and Freddie’s rules, your loan deal will be a matter for you and your lender. You can agree on terms that you both like within a wider regulatory framework.

Gift of equity limits

There’s no dollar limit on a gift of equity. However, gifts of equity over a certain amount may incur a gift tax. That taxable limit is $15,000 for single filers and $30,000 for married couples.

Speak with a tax professional to learn more about the implications of a gift of equity in your specific situation.

How an equity gift affects home buyers

A gift of equity can help bridge the gap between renting and homeownership — especially for first-time home buyers who might have plenty of income but low savings. Here’s what to expect if you go this route.

Use an equity gift as the down payment

You can use a gift of equity for some or all of your down payment.

Imagine your parents own a home that has a current market value of $200,000. But they agree to sell it to you for $160,000. You could count the $40,000 difference as your down payment.

Since that’s 20% of the $200,000 market value, you could qualify for a conventional loan with no private mortgage insurance (PMI) — assuming your credit score and financial circumstances are acceptable.

The same would apply if they sold the home to you for $164,000, giving you a contribution of $36,000 to your down payment. You’d still need $40,000 to get to the magic 20%. But if your savings will stretch that far, you could top up the $4,000 you’re short.

Remember that 20% down is not required. If the gifted equity and your savings don’t stretch that far, you could use a low-down-payment loan or apply for one of the down payment assistance programs that cover your area.

Do you need any of your own cash?

Note that some types of mortgages require minimum out-of-pocket borrower contributions. In these cases, at least part of the down payment would need to come from your own savings

For example, Fannie Mae says that the buyer must contribute at least 5% of the purchase price from their own funds if the home is a second home or a two-to-four-unit principal residence. For ordinary single-family residences, all of the down payment can be in the form of a gift or gifts.

Closing costs and other expenses

If the gift of equity is large enough to cover the minimum down payment on your home loan with some left over, you may be able to use the funds toward your closing costs as well. Just remember that no cash-back is allowed. So you won’t be able to receive “extra” funds for things like moving expenses or renovations.

Qualifying for a mortgage

The down payment amount is one of the biggest factors lenders look at when deciding whether to approve an applicant.

If your gift of equity is enough for a 20% down payment, you’ll have your pick of loan options and interest rates. But it doesn’t need to be so large; many borrowers can qualify with a down payment as low as 3% of the purchase price.

Down payment isn’t the only factor lenders look at, either.

Even if your family member gifts you 20% down, you still have to meet lending requirements. These vary by mortgage program but typically include a credit score of at least 580-620, a clean credit report, a two-year history of income and employment, and a reasonable debt-to-income ratio.

How an equity gift affects the seller

Giving a gift of equity can have personal benefits for the home seller. You may be able to keep a property to which you’re sentimentally attached within the family. And you’re helping someone you love.

Aside from that, the practical effects depend on your personal circumstances.

If you’re selling a principal residence, you’ll need somewhere to live. Of course, if you’re downsizing, the proceeds from the discounted sale may be enough to buy your new home.

Alternatively, you may be moving to an apartment, care home, or “accessory dwelling unit” (a stand-alone independent residence) on the property. Or you might be planning to remain in residence and share the family home with your son or daughter.

Whatever your plans, you must be aware that the person you sell to is going to be the lawful owner of the property. And, no matter what agreements you’ve reached with your adult child, he or she will have an absolute right to do with the home (including any part that you occupy) whatever he or she wishes. Trust is an essential part of these transactions.

Does a gift of equity affect my taxes?

We are not tax experts and do not give tax advice on this site. You should check with your accountant or tax professional if you plan to give or receive a gift of equity. What’s below is for informational purposes only and may not apply to everyone.

Making larger equity gifts has two main tax implications. The first is a gift tax.

Gift tax

The IRS’s website says, “The donor is generally responsible for paying the gift tax. Under special arrangements, the donee may agree to pay the tax instead.”

In 2021, the annual gift tax allowance was $15,000. The total for married couples was $30,000. Any gift amount above that may be taxable.

However, the IRS goes on, “Making a gift or leaving your estate to your heirs does not ordinarily affect your federal income tax.” Confused? Check with a tax professional.

Capital gains tax

If and when the new owner sells the home, capital gains may be taxable. Obviously, if the purchase was made at an artificially low price, the sale is likely to show a bigger profit.

Are you receiving a gift of equity?

If you receive a gift of equity from a family member, you could be well on your way to homeownership.

However, there are certain rules that need to be followed. The gift must be properly documented via a gift letter. And you need to meet your mortgage lender’s requirements for financing — even if the seller is gifting you a 20% down payment.

When you’re ready to buy, your first step should be to check in with a lender and verify you’re eligible for a home loan. You can get started below.