6 Ways to Keep Cash Gifts from Becoming Funny Money
You’re digging under the sofa cushions for spare change trying to fund your down payment. Suddenly, the phone rings: It’s Mom and Dad, calling to offer you a cash infusion. What a lifesaver! It sounds great, and it is. Lots of people count on the largesse of relatives when they purchase a home. In fact, down payments funded (at least in part) with cash gifts are pretty common.
But don’t get hasty and launch a Kickstarter campaign for more moolah to get you into that sweet new house. The mortgage industry inspects cash contributions pretty closely. If those gifts don’t meet their standards, you won’t be able to put them to good use.
Here’s what you need to know.
Putting cash gifts into practice
First of all, there are limits on how you’re allowed to use cash gifts for down payments and purchases. Property type matters: With a conventional loan, you can only use gift money if you’re buying a primary or second home – not an investment property. With the FHA and VA programs, gift money usage is limited to purchasing a primary residence that you’ll be occupying.
In addition, the composition of your funds for a down payment may be restricted based on your loan type. For example, if you put down 20% or more on a conventional mortgage, it can all come from a gift. But if you put down less, part of the contribution must be from your own funds. How much depends on the loan type.
With an FHA or VA loan, all of your down payment can be from gift money; however, if your credit score is below certain thresholds, a portion of your down payment must include your own money.
If your “bro” isn’t really a bro, it’s usually a no‑go
It’s great that your trust‑fund pal offered to pony up some cash, but you’ll probably need to decline the offer. In general, mortgage lenders require that gifts used for down payments must come from family members. That’s why the Kickstarter plan won’t fly – crowdsourced donations, unless they’re all from relatives, won’t make the cut.
There can be case‑by‑case exceptions, but you’d better be able to make a strong argument. A very close family friend who’s acted as a second mom all your life might qualify, especially if you can show what are known as “compensating factors” such as your own outstanding credit score and strong income history. Your college frat brother, on the other hand, probably won’t pass muster.
Lenders, loans, and laundering
A lender will want to make sure the money you’re getting is truly a no‑strings‑attached gift. After all, if the money is a loan in disguise, that affects your financial picture and potentially your ability to meet your mortgage payments. How can you prove the cash is yours free and clear? You’ll need your benefactor to write a gift letter. This should include:
- The gift giver’s name, address and phone number, and relationship to you
- The exact dollar amount of the gift
- The address of the property the gift will be used to purchase, if known
- A declaration that the gift is not a loan, and is not expected to be repaid
- The gift giver’s signature and the date
Some loan programs will also require the gift giver to provide bank statements, so check with your mortgage professional about those requirements.
Your lender will also probably ask you to provide your own bank statements and a paper trail (see below) to make sure the money hasn’t been laundered or funneled in by some suspect source.
Prepare for plenty of paper
In addition to the gift letter, a strong paper trail behind your cash gift is critical because lenders want to know exactly where the money came from.
Here’s how creating that trail might work if, for example, Aunt Matilda sells some stock to give you a cash gift.
- Aunt Matilda needs to document the sale of the stock as well as the transfer of the proceeds from his brokerage account into her bank account.
- Aunt Matilda will then need to write you a check from that bank account (it’s a lot easier to provide proof of a written and cashed checked than a wire transfer). She should make a photocopy or scan of the check to keep for her records. (She’ll also need to write her gift letter.)
- When you get the check, make a copy as well – your lender will want to see it. Then deposit it, in person, into the exact account from which all your money at closing will be drawn. Don’t deposit other checks at the same time; co‑mingling funds can create confusion.
- Get an actual paper receipt.
Big bucks or small potatoes?
Do all cash gifts, regardless of size, need this much documentation? No. For the most part, lenders are concerned about large infusions of cash into your accounts. But defining “large” can depend on the lender.
With many conventional mortgages, eyebrows will raise if there are any cash contributions that are bigger than 50% of your total monthly income. Some programs, such as FHA loans, put this threshold lower, at about 25%.
Suppose your income is $3,000 a month. If you deposit $5,000 in gift money from Uncle Warbucks, you can bet your bottom dollar you’ll need to provide plenty of paper to your lender to verify the source of funds. But a windfall of $50 contributed by your cousin probably isn’t a concern.
There could be exceptions, of course; if you typically keep a tiny balance in your checking account and it suddenly becomes flush with cash, an underwriter might want to see some documentation even if it doesn’t exceed your income‑based thresholds. So be prepared.
Simplify with seasoning
It’s a lot of hassle when cash gifts come in at the last minute. But there’s a completely legitimate way to make it simpler: Make sure the money hits your account at least three months before provide your bank records to your lender. Most lenders want to see two complete months of bank statements, so deposits made farther back in time would be “seasoned” enough to not warrant a closer look.