Gift of Equity: How to Buy a Home From a Family Member

What to Expect in This Blog Post

• What a gift of equity is
• How buying a home from a family member can work
• How equity can be used toward a down payment
• An example of a gift of equity in action
• Who can provide a gift of equity
• Gift of equity requirements for conventional loans
• Potential tax and mortgage considerations
• How to get started with a Michigan mortgage lender

 

TABLE OF CONTENTS:

• What Is a Gift of Equity?
• How Does a Gift of Equity Work?
• Gift of Equity Example: Buying Mom’s House
• Who Can Give a Gift of Equity?
• What Documentation Is Required?
• Can a Gift of Equity Cover the Entire Down Payment?
• Benefits of a Gift of Equity
• What to Know About Gift of Equity and Taxes
• Gift of Equity vs. Selling a Home at a Discount
• Can You Buy Your Parents’ House With a Gift of Equity?
• Why You Can Trust the Treadstone Division of Neighborhood Loans
• FAQs

 

What Is a Gift of Equity?

Buying a home from a family member can look a little different from a traditional home purchase.

Maybe your parents are downsizing and want to keep their house in the family. Maybe a grandparent wants to sell a home to a grandchild for less than its current market value. Or perhaps a family member wants to give you a head start on homeownership without writing you a check for a down payment.

In these situations, a gift of equity may be an option.

A gift of equity happens when a homeowner sells a property to an eligible family member for less than the home’s appraised market value and gives the buyer the difference as a gift.

That equity can potentially be used toward the buyer’s down payment and closing costs, subject to the requirements of the mortgage program.

In other words, instead of handing a family member cash for a down payment, the homeowner can give them part of the value they’ve already built in the property.

How Does a Gift of Equity Work?

Let’s say Mom owns a home that’s worth $500,000.

She wants to sell the house to her son for $400,000 rather than selling it on the open market.

The home’s $500,000 appraised value and the $400,000 purchase price create a $100,000 difference.

That $100,000 can potentially be treated as a gift of equity, provided the transaction meets the applicable loan guidelines.

Rather than the son coming up with a traditional cash down payment, the gift of equity may satisfy some or all of the required down payment.

This can dramatically reduce the amount of money the buyer needs to bring to the table.

And there’s another potential benefit: Depending on the loan structure, having enough equity to meet a conventional loan‘s down payment requirement could allow the buyer to avoid private mortgage insurance (PMI).

The exact amount of equity that can be credited toward the transaction depends on the loan program and circumstances, so buyers should work with their lender before assuming the entire difference can be used as a down payment.

 

Gift of Equity Example: Buying Mom’s House

Here’s a simplified example.

Mom owns a home worth $500,000 and agrees to sell it to her son for $400,000.

If the property appraises for $500,000, and Mom writes a gift of equity letter, there is $100,000 of equity being transferred as part of the family transaction.

If structured correctly, that $100,000 gift could represent 20% of the $500,000 appraised value.

That could potentially allow the son to structure the conventional mortgage without bringing a traditional down payment from his own savings and avoid PMI, assuming he meets the applicable requirements.

Without the gift of equity, the son could instead need to provide a down payment from his own funds.

For example, with a 3% down payment on a $400,000 purchase price, that would mean $12,000 out of pocket, before considering closing costs and other expenses.

The gift of equity can therefore turn existing family equity into a powerful homebuying resource.

Example Detail	Amount
Appraised value	$500,000
Price Mom agrees to sell for	$400,000
Gift of equity	$100,000 (20% of the appraised value)
Down payment from the son’s savings, with the gift of equity	Potentially none, if structured correctly
Down payment without the gift of equity (3% of $400,000)	$12,000, before closing costs and other expenses

This example is for illustrative purposes only. Actual rates, payments, and terms vary based on credit profile, loan amount, market conditions, and individual circumstances. Contact a licensed Loan Officer for a personalized quote. Not a commitment to lend.

Keep in mind: The home’s value needs to be properly documented, and the transaction must follow the applicable conventional loan guidelines. A lender cannot simply assign an arbitrary value to the property to manufacture a down payment.

 

Who Can Give a Gift of Equity?

Gift of equity rules depend on the loan program and the relationship between the buyer and seller.

For conventional financing, eligible donors generally include certain relatives and other permitted relationships under the applicable guidelines.

Common examples can include:

• Parents
• Grandparents
• Children
• Siblings
• Spouses
• Other eligible relatives

The specific relationship matters, so it’s important to discuss the transaction with your mortgage lender before signing a purchase agreement.

A gift of equity also isn’t the same thing as simply selling a home to a family member for a lower price.

The transaction needs to be documented as a gift, and the lender will need documentation showing the property’s value and the amount being gifted.

 

What Documentation Is Required?

A gift of equity is still a real estate transaction, which means there is paperwork involved.

Depending on the loan program and circumstances, the lender may require documentation such as:

• A signed gift letter
• Purchase agreement
• Appraisal or other documentation establishing the property’s value
• Documentation showing the relationship between the buyer and seller, when required
• Closing documentation
• Information showing how the gift of equity is being applied

The gift letter generally needs to establish that the equity is being given as a gift and does not have to be repaid.

Your mortgage lender can explain exactly what documentation will be required for your specific transaction.

 

Can a Gift of Equity Cover the Entire Down Payment?

One of the biggest advantages of a gift of equity is that it may be used to satisfy some or all of the required down payment, depending on the loan program and transaction.

This can be especially helpful when a family member has significant equity in a home but the buyer doesn’t have substantial cash savings.

However, buyers shouldn’t assume that a gift of equity means they will have zero costs at closing.

There may still be expenses such as:

• Closing costs
• Prepaid taxes
• Homeowners insurance
• Inspection fees
• Appraisal fees
• Other transaction expenses

A mortgage professional can help you estimate how much money you’ll actually need to bring to closing.

Benefits of a Gift of Equity

For the right family transaction, a gift of equity can provide several advantages.

It Can Reduce the Buyer’s Cash Needed

Instead of saving thousands of dollars for a down payment, the buyer may be able to use equity transferred by the seller.

It Can Help the Buyer Qualify for Conventional Financing

A larger effective down payment can potentially improve the overall loan structure, depending on the buyer’s qualifications and the property’s value.

It May Help Avoid PMI

If the transaction is structured with enough equity to meet the applicable conventional loan requirements, the buyer may be able to avoid private mortgage insurance.

It Keeps the Home in the Family

For families who want to preserve ownership of a property across generations, selling to a relative can provide a way to transfer the home while giving the next homeowner a financial advantage.

 

What to Know About Gift of Equity and Taxes

A gift of equity can have tax implications for the person giving the gift, depending on the amount and the applicable federal tax rules.

That doesn’t necessarily mean the seller will owe taxes simply because they’re giving equity, but gift-tax reporting requirements may apply in certain circumstances.

Because tax situations vary, buyers and sellers should talk with a qualified tax professional about the potential tax implications before completing a gift of equity transaction.

Your mortgage lender can explain the lending requirements, but a tax professional should address your individual tax situation.

 

Gift of Equity vs. Selling a Home at a Discount

These two concepts may sound similar, but there’s an important distinction.

If a parent sells a $500,000 home to a child for $400,000, the transaction involves a $100,000 difference between the property’s value and the purchase price.

When that difference is formally treated as a gift of equity and documented according to the applicable mortgage guidelines, it can potentially be used toward the buyer’s required investment in the property.

Simply agreeing to sell a home below market value doesn’t automatically mean the buyer gets a $100,000 down payment.

The transaction needs to be structured correctly from the beginning. That’s why it’s smart to talk with a mortgage professional before finalizing the purchase agreement.

 

Can You Buy Your Parents’ House With a Gift of Equity?

Imagine your parents have owned their Michigan home for 25 years. They’ve built substantial equity and are ready to move somewhere smaller.

Rather than selling the home to an unrelated buyer, they decide to sell it to you for less than its current market value.

If the transaction and loan meet the applicable conventional guidelines, the difference between the home’s value and the purchase price may be structured as a gift of equity.

Instead of losing that equity entirely or requiring you to come up with a large cash down payment, your parents can potentially use part of their equity to help you purchase the home.

It’s a win-win scenario for families that want to keep a property in the family while helping the next generation become homeowners.

 

Why You Can Trust the Treadstone Division of Neighborhood Loans

Buying a home from a family member isn’t quite the same as buying a house from a traditional seller. There are additional considerations involving the purchase price, appraised value, gift of equity, down payment, and mortgage structure.

The Treadstone Division of Neighborhood Loans has helped Michigan homebuyers navigate unique financing situations for more than 20 years.

Our Loan Officers can help you understand whether a gift of equity may work for your family, how it could affect your down payment, and what documentation you’ll need to move forward.

If you’re buying a home from a parent, grandparent, sibling, or another eligible family member, talking with a mortgage professional early can help you avoid structuring the transaction in a way that creates problems later.

Treadstone does not provide tax, financial, or legal advice. Please consult a licensed CPA, financial advisor, or attorney for guidance specific to your situation.

 

FAQs

What is a gift of equity?

A gift of equity occurs when a homeowner sells a property to an eligible buyer for less than its appraised value and gives the difference as a gift. Under applicable mortgage guidelines, that equity may be used toward the buyer’s down payment and certain closing costs.

Can I use a gift of equity to buy my parents’ house?

Potentially, yes. A parent may be able to provide a gift of equity when selling a home to a child, provided the transaction meets the requirements of the applicable mortgage program.

Can a gift of equity cover the down payment?

A gift of equity may be used toward some or all of a required down payment, depending on the loan program and circumstances. The buyer may still need money for closing costs and other expenses.

Do I have to pay PMI with a gift of equity?

Not necessarily. If the gift of equity provides enough equity to meet the applicable conventional loan requirements, the buyer may be able to avoid PMI. Your lender can determine how the transaction would be structured.

Does a gift of equity have to be repaid?

Generally, a qualifying gift of equity is not expected to be repaid. The lender will typically require documentation confirming that the funds or equity are a genuine gift rather than a loan.

Does the home have to be appraised for a gift of equity?

The lender will generally need a reliable determination of the property’s value to establish the amount of equity involved. Specific valuation requirements depend on the loan program and transaction.

Can I buy a family member’s house below market value?

Yes, family members can agree to sell a home for less than its market value. However, if you’re planning to use the difference as a gift of equity toward a mortgage, the transaction needs to be structured and documented according to the applicable loan guidelines.

Is a gift of equity taxable?

A gift of equity can have tax and reporting implications for the person giving the gift. Buyers and sellers should consult a qualified tax professional about their individual circumstances.

Can I use a gift of equity with a conventional loan?

Yes, conventional loan guidelines allow qualifying gifts of equity in certain transactions. The buyer, seller, property, and transaction must meet the applicable requirements.