How Does a Gift of Equity Loan Work

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October 20, 2022

A Gift of Equity Loan is a type of home loan that allows the borrower to purchase a home without having to come up with all of the money for the purchase price. The down payment for the loan can be gifted by a family member or friend. This type of loan can be beneficial for buyers who may not have enough money saved up for a traditional down payment.

If you’re selling your home to a family member or close friend, you may be able to give them a “gift of equity.” This means that you sell the home for less than its market value, and the buyer uses the difference as part or all of their down payment. For example, if your home is worth $200,000 but you sell it to a family member for $150,000, they would only need a $50,000 down payment (assuming they qualify for a loan with a 3.5% down payment).

There are some rules and restrictions that come with gift of equity loans: • The buyer must be an immediate family member (parent, child, sibling) or someone who has lived with you for at least 12 months before buying the home. • You can only give them enough equity to cover their down payment and any closing costs – you can’t just give away your house!

• The transaction must be arms-length, meaning that you can’t force the sale or set an unfair price. • You will still need to pay any capital gains taxes on the difference between your original purchase price and the sales price.

How Does a Gift of Equity Loan Work
How Does a Gift of Equity Loan Work 2

Credit: www.investopedia.com

How is a Gift of Equity Paid?

A gift of equity is a transfer of ownership of a property from one person to another without any monetary exchange. The most common type of gift of equity is when a parent gifts their home to a child. In order for the child to receive the property, the parents must first deed the property over to them.

The child will then be responsible for paying any remaining mortgage balance on the home as well as taxes and insurance.

Do You Need a down Payment With a Gift of Equity?

If you are purchasing a home from a family member or friend, you may be able to do so with a gift of equity. This is when the seller agrees to give you a certain amount of money towards the purchase price of the home as a gift, which can help you avoid having to come up with a down payment. However, not all lenders will allow for a gift of equity and some may require that at least part of the down payment come from your own funds.

It’s important to speak with your lender ahead of time to see if this is an option for you and what, if any, restrictions they may have in place.

How Do You Handle Gift of Equity?

When you receive a gift of equity, the donor must provide a letter stating that the funds are a gift and not a loan. The lender will also need to approve the transaction. Once you have this documentation, you can proceed with your mortgage application.

The amount of the gift will be counted as part of your down payment, and it may help you to avoid paying private mortgage insurance (PMI). Be sure to work with a loan officer beforehand to see how the gift of equity will impact your loan approval and terms.

Who Pays Taxes on a Gift of Equity?

If you give someone a gift of equity, the recipient does not have to pay taxes on the value of the gift. However, if the recipient later sells the property, they will have to pay capital gains tax on any increase in value from the time they received the gift. For example, let’s say you own a house that is worth $200,000.

You decide to give your child a gift of equity by transferring ownership of the house to them. Your child does not have to pay any taxes on the $200,000 value of the house at the time of transfer. However, let’s say that five years later, your child decides to sell the house.

The house is now worth $250,000. When your child sells it, they will have to pay capital gains tax on their $50,000 profit.

Gift of Equity Explained

Gift of Equity Pros And Cons

A “gift of equity” refers to the transfer of ownership of a property from one family member to another, usually at a reduced price. The most common type of gift of equity is when parents sell their home to their child at a price below the market value. There are several pros and cons to consider before entering into a gift of equity transaction:

Pros: 1. The buyer may be able to purchase the property without a down payment, or with a smaller down payment than would otherwise be required. 2. The interest rate on the mortgage may be lower than it would otherwise be, since the loan-to-value ratio will be lower.

3. There may be tax benefits for both the buyer and seller in some cases – consult your tax advisor for details. 4. It can be a way to help out a family member who might not otherwise be able to afford their dream home. 5. It can make things simpler if the property is being transferred between family members who are already familiar with each other and trust each other – there’s no need to go through an arm’s length transaction with strangers.

6.. In some cases, it may even help the seller avoid paying capital gains tax on the sale if they meet certain criteria set by the IRS (again, consult your tax advisor). Cons:

1. There may be potential negative consequences if either party defaults on their obligations under the contract – this could lead to legal action and/or damage to relationships within the family . . . so make sure everyone understands what they’re agreeing to before going ahead! 2,. If either party later decides they want out of the deal, unwinding it can sometimes be complicated and/or expensive . . . again, something that should ideally all be sorted out upfront before anything is actually signed over or transferred.

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Conclusion

A gift of equity loan is a type of mortgage loan where the down payment is given as a gift from a family member or close friend. This can be an attractive option for first-time home buyers who may not have the savings for a traditional down payment, but it’s important to understand how these loans work before signing on the dotted line. The most important thing to know about a gift of equity loan is that the interest rate will likely be higher than a traditional mortgage loan.

This is because the lender is taking on more risk by lending money to someone with no down payment. Additionally, you may be required to pay private mortgage insurance (PMI) if your down payment is less than 20% of the purchase price. Before applying for a gift of equity loan, make sure you understand all the terms and conditions involved.

You don’t want to end up in over your head financially just because you didn’t take the time to learn about this type of financing option.

About the author 

Abrar Hossain

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