Down Payment Assistance Programs

USDA Loan Rules Regarding Gift Funds for Down Payment

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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.

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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.

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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.

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What are the Down Payment Gift Tax Consequences?

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The down payment is often the hardest part of the home buying process. It’s often the reason people continue to rent, rather than buy a property, because they don’t have enough money to put down on the home.

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Fortunately, many programs allow the use of gift funds. In other words, a family member, close friend, or employer may gift you money to put down on your home. Many people wonder about the tax implications of doing this. Does it affect you, the donor, or neither?

Accepting Gift Funds

As the recipient of gift funds, you’re off the hook when it comes to the IRS. They don’t tax the money because the donor already paid taxes on it. The money is a gift, not money you earned for doing something.

Of course, this must be documented so that the IRS knows it is a gift. Fortunately, lenders require this too. The donor must write a letter that states the money is a gift, the reason for the gift, and the amount provided. As long as the donor puts a statement in the letter that this money is a gift, you don’t have to worry about the taxes on your end.

Giving the Gift Funds

The donor may or may not have tax implications for giving you money. It depends on the circumstances. The important thing to know is that the donor probably won’t have to pay taxes this year or the year they gift you the money. Here’s why.

Each person has a lifetime amount they can gift without tax implications. That lifetime cap is $11.4 million right now. Remember, this is over an entire lifetime. On top of the lifetime cap, each person has a $15,000 exclusion per person. What this means is that the first $15,000 that you gift to any one person won’t count toward your lifetime cap and you won’t have to worry about paying taxes on it.

Here’s an example:

Your dad agrees to help you with your down payment. He offers to give you $15,000. The lender approves it, so you accept it. Your dad doesn’t have to pay any taxes on the gift he gave you and it doesn’t decrease his lifetime cap because it’s not over $15,000.

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Now if your dad gave you $25,000 for your down payment it would look a little different. Since the $25,000 is more than $15,000, the $10,000 difference would count against his lifetime cap. Now obviously he still has a long way to go before he meets the cap, but it’s worth knowing that it decreases the cap.

Married Couples and Gifts

The maximum gift limit applies separately to married couples. In other words, the gift must be in one spouse’s name or the other – not both. This can work to your advantage. You can split the gifts if the total amount puts either of you over the $15,000 limit. For example, a $30,000 gift could be $15,000 from your dad and $15,000 from your mom. This keeps them exempt from the taxation while staying within the law.

Filing Taxes as a Donor

Keep in mind that even if a donor doesn’t owe taxes for gift funds, he or she may still have to file the proper tax forms. Donors must complete IRS Form 709 – US Gift Tax Return. The form must be completed in order to keep track of the gifts provided that affects your lifetime maximum. You must file the return with your standard 1040 by April 15 (October 15 if you extend).

Handling Gift Funds with Your Lender

Aside from the tax implications, you as the recipient must know what your lender requires. Don’t accept gift funds without first talking to your lender. Find out what they need in regards to proof of the gift. A gift letter is a given – all loan programs require that, but what else do they need? Many lenders require a paper trail, ensuring the money belongs to the donor and isn’t a loan somewhere down the line that affects your debt ratio and your mortgage eligibility.

Lenders will tell you how to handle the disbursement of funds and what proof they need that the transaction took place. Working closely with your lender and your donor’s tax advisor will have the best outcome. Everyone will come out of the process with the end goal met – helping you to buy a home.

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