A “Gift of Equity transaction” can be a creative solution for helping cash-challenged borrowers afford the required down payment.

Until recently, the gift of equity in transactions has been rare (I’ve done a dozen – all within the past five years,

With the aging of the “boomer” population and California’s Prop. 13 rules, these will be much more common.

So, if you have a client whose family member(s) wish to sell (transfer) their property to another family member (who has little or no down payment) while still preserving a low-tax basis, a gift of equity is the best option.

The seller (aka “donor” of the gift of equity) sells the property at a specific price, which is worked out between them and their relative(s).

For lending purposes, the (only) definitions of “family”

A “family relationship” is defined as “relatedness or connection by blood or marriage or adoption or domestic partnership.”

For Example, here are the people that are classified as family members:

Children, parents, or grandparents.

A child is defined as a son, stepson, daughter, or stepdaughter-parent or grandparent, including a step-parent/grandparent or foster parent/grandparent.

Spouse Or Domestic Partner of the primary borrower’s legally adopted son or daughter, including a child who is placed with the borrower by an authorized agency for legal adoption, a foster child of the borrower’s brother, stepbrother of the borrower’s sister,

Stepsister of the borrower, uncle of the borrower, aunt of the borrower, son-in-law of the borrower, daughter-in-law of the borrower, – father-in-law of the borrower, mother-in-law of the borrower, brother-in-law of the borrower

Lenders rarely require proof of a familial relationship, but claiming any of the following as a relative /family member is fraud.

Lifelong family friends, boyfriends/girlfriends, and fiancées are examples of people who are NOT family members, so there is no room for creativity.

FBI: Housing Fraud – “What We Investigate”

Lending regulations state that even if the seller (donor) is a relative, the seller “MAY NOT ” be or have ANY affiliation with the builder, developer, landlord, real estate agent, or appraiser.

And to refresh your memory, if someone commits fraud and the FBI shows up with bracelets, the bracelets won’t be from Nordstrom, and the FBI agent won’t even remotely resemble Dakota Johnson (lol).

Constructing the Transaction

The difference between a property’s sales price and the “recipient” (new) loan amount is defined as the “amount of gift equity” (gift).

The seller’s “Gift Equity” can be ALL or PORTION of a down payment.

If the ENTIRE down payment is a “Gift of Equity,” it must be at least 20% of the purchase price.

If the Gift of Equity is LESS than 20% of the purchase price, buyers must still have AT LEAST 5% of the cost from their funds.

Establish a Price And Loan Amount

Sellers who gift equity often only want to net a certain amount of cash.

There’s no need to sell the home at market value, as this inflates property taxes, transfer, title, and escrow fees.

For example, if “Mom and Dad” have a $2 million home, they may only want to sell it to their kids for $500k, using a gift of equity.

WHY?: The parents may only want to net $250k from the transaction (in addition to paying off the current mortgage is $100k); they can structure the sale like this:

The gift of equity will be $100k; the kid’s loan amount will be $350k (just enough to give parents the $250k in cash they want AND pay off the parent’s $100k loan).

If the kids want additional cash for home improvements after COE, the parent’s gift of $100k remains the same; the kids could raise their loan amount to $400k, – and the parents can (after the close of escrow) gift back the additional $50,000.

However, there are tax implications with all of these options.

In Calif., with Prop.13, there are re-assessment exemptions when properties are transferred linearly from parent to child (or grandparent to grandchild); so, buyers and sellers should involve a CPA or a skilled tax planner.

Documentation Requirements

Gifts must be evidenced by a GIFT LETTER signed by the donor.

The gift letter must:

• specify the dollar amount of the gift;

• specify the date the funds were transferred (in this case, it’s at COE)

• Include the donor’s statement that no repayment is expected;

• Indicate the donor’s name, address, telephone number, and relationship to the borrower.

Verifying Donor Availability of Funds and Transfer of Gift Funds

The lender must verify that sufficient funds to cover the gift are either in the donor’s account or transferred to the borrower’s account.

In the case of gift equity transactions, the gift funds are verified by the property appraisal.

Other Types of Occupancy

Gift of Equity transactions can involve FHA, VA, or Conventional financing.

Types of property that are eligible for a gift of equity (in addition to the owner-occupied transaction) are “second homes” and investment properties (up to 4 units).

Fun Facts

The transaction will be tedious. Expect a 60-day closing and have the borrower get a DU loan approval while the transaction is being completed.

Persuade the client to pay you a flat broker fee so they can use an agent to guide the transaction and pick the escrow and title company.

Note: It will earn you a fee and future referrals as well. Let’s face it; they’ll be calling you for advice anyway.

Have a real estate agent structure the purchase contract so that all parties sit at the table together instead of going back and forth.

If personal family business needs to be discussed, be prepared to leave the room while issues are settled.

Use a standard purchase contract. If a PC form is unavailable, most lenders will allow escrow instructions to be used instead of the PC.

Get a termite inspection and make repairs BEFORE the appraiser comes to the home, and the transaction will go much smoother.

Ensure your lender/broker of choice underwrites this type of transaction; many (ie, no banks or credit unions) don’t.

I chose an MLO with experience; the transaction is tedious and not for an inexperienced lending professional.

Copywrite © August, 2018 Daniel Dobbs MHM Mortgage /// All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law. For permission requests, write to the publisher, addressed “Attention: Daniel Dobbs, Author- VP-Broker Mutual Home Mortgage 265 S. Randolph #120 Brea, Ca. 92821 Cell: 949 250-3981 Dandobbs6@gmail.com NMLS #307631 BRE #00986886