What if your parents were willing to loan you the money for the down payment? Would a lender allow it?
Typically, the answer is ‘no.’ Parents can’t lend you money for a down payment; however, they can gift you the money, which is different. Keep reading to learn how this works.
Down Payment Gifts
Parents are able to give their children money for a down payment on a home. Notice we said give and not lend. There is a big difference in the eyes of the lender. Gifted funds don’t require you to pay the funds back. The relative (your parents) give you the funds.
Most loan programs allow the use of gift funds, including conventional and FHA loans. In fact, for both loan types, you can accept the entire amount of the down payment as a gift. In order to use the funds, though, you have to go through the proper steps, which we discuss in detail below.
How to Create a Paper Trail for the Gift Funds
The biggest factor when dealing with gift funds is proving their origination. You need to be able to prove to the lender beyond a reasonable doubt that the funds are a gift. Here are the steps:
- Your parents must write you a check for the amount of the gift funds.
- You accept the check, make a copy of it, and deposit the entire check in the account you will use to make the down payment and pay the closing costs.
- Keep a copy of the deposit ticket.
- Get a copy of the canceled check.
This is how to take care of the documentation on your end. Your parents must also provide a paper trail. Their paper trail entails where the funds originated and ends with a gift letter. Your parents must provide the last two months’ of bank statements to show that they had possession of the funds before giving them to you.
If they sold an asset, they can provide a Bill of Sale to show the amount of the sale rather than providing two months of bank statements. The lender just needs to know beyond a reasonable doubt that the funds are not a loan in someone else’s name.
The Gift Letter
Another big part of the process is the gift letter. Your parents must write this letter to show the lender the amount of the gift as well as to attest to the fact that the money isn’t a loan.
The gift letter must include:
- The date
- The amount of the gift
- The person intended for the gift
- The reason for the gift (the address of the home)
- A statement that the funds aren’t a loan and no repayment is expected
- Your parent’s signatures
The gift letter is a legal document with the lender stating that the funds are a gift and in no way are they a loan that you must repay.
What Happens if Parents Lend You Money for a Down Payment?
If your parents don’t want to give you the money and need it to be a loan, it affects your debt ratio. The lender will need to know the terms of the loan in order to figure out how it affects your total monthly liabilities.
In other words, the lender needs to know the amount of the monthly payment and the length of the term. They will add this figure to your monthly debts to figure out your total debt ratio. Your debt ratio for a conventional loan cannot exceed 36% of your gross monthly income and your DTI for an FHA loan cannot exceed 41% of your gross monthly income. If you are already borderline with your current debts, a down payment loan could put you over the threshold.
You may think your lender won’t know if you get a loan from your parents, but they will. First, lenders will see the large deposit in your checking account when they verify your assets. They will inquire where the funds originated. If you don’t have a gift letter from your parents, the lender will assume it is a loan and ask for the loan’s terms.
Your parents can help you with your down payment, preferably with gift funds. If they give you a loan, be prepared to share the details with your lender so they can include it in your debt ratio. Either way, the funds can help you with your down payment on an FHA or conventional loan. If you can’t qualify because of the lack of a down payment, you can try a VA loan (if you are a veteran) or a USDA loan (if you buy a rural home), as both loans don’t require a down payment.