Gift of Equity: How to Use This in a Real Estate Transaction
You might have heard the term “gift of equity” used in real estate transactions and are wondering what it means. A gift of equity is a way for a seller to help a buyer purchase their home.
From explaining this concept to going over the advantages and disadvantages, here’s everything you need to know about the gift of equity.
What Is a Gift of Equity?
A gift of equity is when a seller helps a buyer financially by selling the house for a lower price than market value. Typically this happens among family members or close relations, such as a parent selling their home to a child or someone selling to a domestic partner.
A gift of equity can be used to purchase a primary residence, second home, or investment property.
The difference between the sales price and the appraised value of the house is considered the gift of equity amount. The majority of mortgage lenders will allow the buyer to use the equity as part of the down payment.
How Does a Gift of Equity Work?
Let’s say that you own a house that is worth $700,000 and a family member, such as your child, is interested in purchasing the house. However, they might be having difficulty coming up with the money to use as a down payment for the home.
In this case, you might consider selling the house for less than what it is valued at — perhaps $650,000 instead of $700,000. In this scenario, you’d be giving your family member a gift of equity worth $50,000.
Buyer and Seller Roles in Gifts of Equity
There are a few key differences in the seller’s role and the buyer’s role for giving and receiving a gift of equity.
The Seller’s Role
The majority of the burden lies with the seller for a gift of equity. The seller is responsible for signing a gift of equity letter, which contains vital information about the gift.
This letter usually includes:
- The address of the house
- The amount of equity that the seller is gifting
- The relationship between the seller and buyer
- A statement explaining that the equity is a gift and does not require repayment
Additionally, sellers are required to hire an appraiser to assess the current market value of the house. An appraiser will conduct a complete assessment of the home, including both interior and exterior, to determine the current market value of the house. By doing this, the seller will be able to calculate the amount of equity that they are giving.
Sellers should be sure to thoroughly look into Internal Revenue Services (IRS) guidelines when it comes to gifts like this, as there may be tax implications.
The Buyer’s Role
When it comes to the buyer’s responsibility, buyers go through the normal steps for purchasing a house — namely, applying for a mortgage.
A borrower will still be able to qualify for a mortgage loan through a lender, but they will need to show that they can meet the requirement established by the lender.
When qualifying for a mortgage, the homebuyer must meet a criteria for credit score and income, which varies from lender to lender. We recommend buyers get quotes from more than one lender so they can compare rates.
The buyer has the option to choose from a variety of home loan types, including:
- Conventional loans: This type of loan typically comes with 15-year, 30-year, or adjustable rate options.
- Department of Veteran Affairs (VA): This loan is available to active-duty service members, veterans, and eligible surviving spouses — no down payment required.
- Federal Housing Administration (FHA): This is a government-backed mortgage loan designed to help low- to moderate-income families attain homeownership.
Additionally, the majority of lenders will allow a borrower to put the equity towards their down payment.
If a buyer pays a 20% down payment, they will avoid Private Mortgage Insurance (PMI), which is an added insurance policy for homeowners who put down less than a 20% down payment.
Gift of Equity Pros and Cons
So, is giving a gift of equity right for you? Should you use it as a down payment if you receive this bonus piece of equity?
Here are some advantages and disadvantages to consider.
Here are some of the benefits of the gift of equity:
- Makes it easier for buyers to get a mortgage. Selling the home for less than market value can make it easier for the buyer, such as a family member, to buy a home as it will lower the purchase price.
- No real estate agent commissions. Since the seller is selling to someone they know, a real estate agent is not needed to oversee the home purchase transaction. This will also help the buyer and the seller save money on some closing costs and commission fees.
- May get a better interest rate. Since buyers can use a gift of equity, their loan amount will require less debt financing for the mortgage lender. Because the lender is taking on less risk, the buyer might receive a competitive interest rate.
If you’re considering gifting equity, here are some cons to keep in mind:
- Sellers can lose out financially. Since the sales price is lower than the real market value of the home, the seller will lose out financially.
- Possible legal fees. A gift of equity letter is required to complete the transaction, which means that sellers should account for paying legal fees when it comes to drawing up the contract.
- The home cannot have a mortgage. In order for a house to qualify for gift equity, it cannot have a mortgage. The debt on the home must be completely paid off in order to transfer the deed.
FAQs About Gifts of Equity
Now that you understand what a gift of equity is, here are some common questions you might still have.
What Is the Max Gift?
The IRS provides guidelines on how much the seller is able to give in home equity without triggering a gift tax. For 2023, a married couple can give up to $34,000 and a single person can give up to $17,000 to an individual per year.
If they decide to give more, they might find themselves subject to a gift tax. A gift tax is a federal tax on the transfer of a house from one individual to another while receiving nothing, or less than full value, in exchange.
Does a Gift of Equity Have to Be From a Family Home?
A gift of equity can either be from a family member or someone the seller has a personal relationship with. However, loans backed by the federal government may have restrictions when it comes to who you can gift. For instance, most government-backed loans require that gifts of equity can only be given to family members.
What Are the Tax Responsibilities?
When it comes to tax implications, gifts of equity are not taxable to the recipient. The seller who is transferring the home is the one required to file any necessary gift tax return and pay any gift tax owed, rather than the recipient who is buying the house and receiving the gift of equity.
Do All Loan Types Allow a Gift of Equity?
The majority of conventional loans allow homebuyers to use gift money for their down payment or closing costs. FHA loans accept a gift of equity, but only if it comes from an acceptable source, such as a family member. Meanwhile, VA loans do not require a down payment, which means that gifts of equity are rare.
Explore Selling Your Home With Aalto
A gift of equity provides a way for sellers to assist buyers in becoming homeowners. If you’re interested in giving away equity, then it’s essential to understand the ins and outs of how a gift of equity works.
From start to finish, Aalto is ready to guide you through the process so you won’t need to pay the extra costs of hiring a real estate agent or deal with the headaches of the traditional real estate process.
If selling via the gift of equity isn’t the right option after all, you can add your house to our platform in minutes to explore the market for your home at your price — no commitment or contract required.
Aalto’s talented team of professionals is there to provide advice and answer questions, whether you have questions about what type of mortgage is right for you or how to find the fair market value of your home.
Sign up on Aalto today to get started on finding the right buyer for your house.