11/25/2019 | Casey Fleming | Prices are very high in Silicon Valley. One of the biggest barriers first time home buyers face is coming up with a down payment. Many Silicon Valley home buyers solve this by getting a down payment gift from the Bank of Mom and Dad.
As long as you don’t need to borrow more than the conforming loan limit in your area, you can get into a very good loan with only 3% down. You need 5% down for a high-balance conforming loan limit. But if you need more than the current conforming loan limit (and in Silicon Valley you probably do) you’ll really need to have 20% down. You can get in with less, but the loan becomes very expensive.
Related: What is the Conforming Loan Limit?
A Down Payment Gift Might Be Taxable
A down payment gift from the Bank of Mom and Dad (or your favorite uncle) has become quite common, therefore, for first-time homebuyers in Silicon Valley. The IRS limits the annual gift one person can give another, however, to $15,000 before a taxable event might kick in. While this author is not an accountant or a tax expert¸ most of the rules regarding this are pretty easy to find.
Before making any decision to give or not to give because of tax considerations, you must consult with your tax preparer or a qualified CPA. When you do, here are some interesting strategies that you may want to bring up.
How to Multiply Your Down Payment Gift
The median home price in Silicon Valley is now about $1.4 million. 20% of that is $280,000, and of course you will need enough for closing costs and reserves – typically 3 months of housing payments. At that price, this could mean a reserve of $15,000 or more. It’s not hard to see that a $15,000 gift doesn’t go very far. What to do?
The gift limit of $15,000 applies to one person giving to one other person, each year. There are some creative ways you can use this to your advantage.
We are very close to the end of 2019. To double your gift, gift $15,000 before December 31st and another $15,000 after January 1st for a total of $30,000.
To quadruple your gift, if the home buyers are a couple and the Bank of Mom and Dad are, in fact, Mom and Dad, then Mom can gift each member of the young couple $15,000 each, and Dad can do so as well, for a total gift of $60,000.
To double that again, gift $60,000 before December 31st and again after January 1st, for a total gift of $120,000. That is significant enough to make a real difference for the young home buyers.
What is a Down Payment Gift (Really)?
We know that many folks will “gift” down payment money to their children expecting to have it paid back. If so, it’s not really a gift, it’s a loan. If it is truly a loan, then the lender will want to see a Promissory NOTE that spells out the terms of the loan, and will count the payment on the loan as an additional monthly expense for the homebuyers. If their debt ratio (ratio of total monthly obligations to gross income) is still within guidelines it’s not an issue, but for home buyers who are tight on their debt ratios it could force the lender to decline the loan.
But there’s more. Guidelines say that a loan from family for the purpose of the down payment cannot be a personal note – it must be secured against the property and therefore be a second mortgage. The trouble with this is that the interest rate on the first mortgage will be higher, because pricing on mortgages is very sensitive to the size of the down payment (or, more accurately, the loan-to-value ratio.) Using a gift can help you get the best interest rate possible; using a second mortgage from the Bank of Mom and Dad loan will cost you more.
If it is actually a loan and not a gift, calling it a gift is problematic. The lender is making a lending decision based on your representations. If you represent falsely, you are technically committing mortgage fraud. As a donor, you will sign a gift letter stating your relationship with the home buyers, stating that the money is a gift and that you do not expect repayment, and acknowledging that lying about that is fraud. Many donors are understandably uneasy about this.
The Seasoning Loophole
The lender will only ask for the last two bank statements to document that the homebuyer has enough money for the purchase. If the down payment gift is received prior to the dates covered by the statements presented to the lender, the lender won’t know that a gift has been received and therefore won’t ask about it.
If the money is, in fact, a gift, then this doesn’t really change whether or not the loan can get done or the pricing of the loan – it just simplifies the paperwork. If, instead, the money is meant to be a loan, then the home buyer should report the loan (and the terms) to the lender to avoid committing mortgage fraud.
Down Payment Gifts Done Right
Don’t let the complexity of the down payment gift scare you away. For most home buyers, properties are appreciating faster than you can save money for the down payment. You might end up chasing the market and never buying.
A down payment gift is often the tipping point that helps a young home buyer get into their first home, and now is the time of year to have a serious discussion about the best way to do it. The end of the year approaches fast!
Sources referenced for this article:
This article represents the opinions of Casey Fleming, and not necessarily those of C2 Financial Corp. This analysis was prepared with the best information available at the time it was written. Neither Casey Fleming, nor C2 Financial Corp., have any magical insider information about bond markets, real estate markets or mortgage markets that would make economic projections any more reliable than any other source. No warranty is made that the outcome will reflect the projections in this article, and neither Casey Fleming nor C2 Financial Corp. are responsible for decisions that you make regarding your own choices about your real estate or mortgage or those of your clients.
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