A gift of equity is one of the most underused tools in the MLO toolkit for intra-family property transfers. When a family member sells a home below appraised value, the difference can be applied to the buyer's down payment, eliminating or reducing the need for cash from the buyer.
How a Gift of Equity Works
The seller agrees to sell below the appraised value and applies the difference as a gift toward the buyer's down payment. If a home appraises at $400,000 and the seller agrees to a $360,000 sale price, the $40,000 equity difference (10%) satisfies the down payment requirement without the buyer needing to bring cash. The buyer's effective LTV is based on the appraised value, not the sale price.
Agency Rules
- ✦Fannie Mae: gift of equity from a family member is acceptable for primary and second home purchases; not eligible for investment properties; no repayment can be expected
- ✦Freddie Mac: same family member requirement; investment property gift of equity is not permitted
- ✦FHA: gift of equity from a family member is allowed; the appraised value drives the LTV calculation; family member defined under HUD guidelines to include spouses, parents, grandparents, siblings, children, and domestic partners
- ✦VA: gift of equity from a family member is acceptable; since VA requires no minimum down payment, the gift can apply toward closing costs as well
Documentation Requirements
Required documentation includes a signed gift letter from the seller stating the dollar amount, that no repayment is required, and the relationship to the buyer. An appraisal supporting the claimed appraised value is essential; the equity is calculated from this figure. The closing disclosure must show the gift of equity credit. The lender will verify the appraisal and confirm the transaction structure does not involve an inflated appraisal.
Key Pitfall: Non-Arm's-Length Disclosure
Most lenders require a non-arm's-length transaction disclosure for family sales. If the gift of equity is in fact a disguised loan with an expectation of repayment, that is mortgage fraud regardless of how the transaction is described. Any verbal or written side agreement for repayment invalidates the gift structure. If the transaction involves a seller who is also the borrower's employer or business partner, additional scrutiny applies regardless of family relationship.
Aria can walk through gift of equity documentation requirements for any program and confirm which family member relationships qualify under specific agency guidelines. Ask at vicariointel.com.
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