Gift of Equity: FHA vs. Conventional Rules MLOs Must Know

A gift of equity occurs when a property seller (typically a family member) sells the property below appraised value and the difference between the sale price and appraised value is used as the buyer's down payment. The gift of equity is documented and used in place of cash funds from the borrower.

FHA Gift of Equity Rules

FHA allows gifts of equity only from family members as defined in the FHA handbook: parents, grandparents, children, siblings, stepchildren, aunts, uncles, and other close relatives including domestic partners. The donor must sign a gift letter stating no repayment is required. The appraised value determines the property value, and the gift of equity covers the gap between the sales price and the appraised value up to the required minimum down payment.

Conventional Gift of Equity Rules

• ✦Fannie Mae and Freddie Mac allow gifts of equity from the same family member categories as gift funds
• ✦A gift letter is required along with a settlement statement or closing disclosure confirming the transfer of equity
• ✦The LTV is calculated against the appraised value, not the sales price, so a gift of equity can result in a lower LTV than expected
• ✦For investment properties, gifts of equity are not permitted on conventional loans

Appraisal and LTV Mechanics

The appraisal establishes the fair market value. The settlement statement reflects the sale price (which is lower than appraised value). The gift letter documents that the equity difference is a gift. For LTV purposes, the lender calculates LTV using the appraised value as the denominator, not the purchase price. This means a gift of equity transaction can produce a very favorable LTV ratio even when no cash changes hands.

Documentation Checklist

The underwriter will require: a signed gift letter specifying the amount, the relationship between donor and recipient, and a statement that no repayment is expected; a preliminary HUD-1 or closing disclosure showing the sales price; the appraisal; and in some cases a letter from the donor explaining their relationship to the buyer. For FHA, the donor must also show they have sufficient equity (which the appraisal confirms).