USDA loans don’t require a down payment, so you probably think you don’t have to worry about gift funds for this loan. However, there are times when USDA borrowers need funds from others to cover their closing costs. Just because you don’t have to put money down on the home doesn’t mean the lender and involved third-parties won’t charge closing fees.
What are the rules for gift funds and USDA loans? Keep reading to find out more.
What are Gift Funds?
First, let’s look at the definition of gift funds. Any funds you receive from a relative, close friend, or employer in connection with the purchase of your home are gift funds. The donor provides you with the necessary funds to cover the cost of buying the home, or at least part of the cost.
Before you just accept funds from any friend or relative, though, you should know what the USDA requires regarding gift funds.
How Can you Receive Gift Funds?
Your relative, friend, or employer offers you great assistance by providing you with gift funds, but they can’t just hand you a check and think it’s all done. The USDA and their lenders require a specific process to occur in order to receive the funds:
- The donor gives you the funds in the form of a check. A cashier’s check is best.
- Make a copy of the check before you deposit it in your bank account.
- Deposit the check in the bank account that you’ll use to withdraw funds for closing.
- Keep a copy of the deposit ticket for the lender.
- Have a copy of your bank statement showing the deposit for the exact amount of the check.
- Leave the money untouched.
The Importance of the Gift Letter
In addition to the above process, the donor must also write a Gift Letter. This letter is just a statement letting the lender know the following:
- The date of the gift
- The amount of the gift
- The reason for the gift
- The address of the home the funds are intended for use on
- The fact that the funds are not a loan
The donor should sign and date the letter to complete it.
Tracing the Donor’s Funds
Even though the donor provided a gift letter and you followed all of the necessary steps, the lender still must verify the origination of the donor’s funds. In other words, the lender needs to make sure that the donor didn’t borrow the funds somewhere. This is a way for borrowers to hide a loan, by having a ‘donor’ take the loan out and then gift them the funds.
Donors can prove origination of the funds by:
- Providing their last two months’ of bank statements to prove that they have had ownership of the funds at least that long
- Showing proof of the sale of an asset, such as a car, boat, or stocks
- Providing investment statements for accounts that they withdraw the funds, such as a money market account
What can Gift Funds Cover?
Gift funds for a USDA loan can cover the closing costs or even help you get a little equity in your home. It’s up to you how you want to apply the funds. If you have the money to cover the closing costs on the loan, the gift funds can be your down payment. Any money you put down gives you immediate equity in the home, which isn’t a bad thing since most USDA borrowers have no equity in their home or very little equity for quite some time.
Other Ways to Cover USDA Closing Costs
What if you don’t have access to gift funds and you don’t have the money for closing costs? There are a few ways that you can still get help:
- Ask the seller for help – Some sellers will give seller credits to help borrowers with their closing costs. They typically do this when there’s room between the sales price of the home and its actual value. The seller will typically negotiate a higher sales price with you in order to give you the credit for your closing costs. This way the seller walks away with the same profit and you get the loan approval that you need.
- Roll the costs into the loan – You may be able to ask your lender to roll the closing costs into your loan. Again, the value of the home must be higher than the sales price, though. Lenders cannot give you a loan amount that is higher than the value of the home. This would put them at risk for default.
- Negotiate a no-closing cost loan – Some lenders offer a no-closing cost loan. This means that you don’t pay any closing costs at the closing. Instead, the lender covers them for you. In exchange for the no closing costs, the lender will charge you a slightly higher interest rate.
Gift funds are one of the easier ways to get help with your USDA closing costs or even the down payment, should you want to make one. As long as you follow the rules and prove the origination and transfer of the funds, you should be able to use the gift funds to help you buy the home you want.