Understanding Gift Funds and USDA Home Loans

Gift money can pay your closing costs!

Gift money in a gift boxIf you’re thinking of buying a home, you may be considering a USDA loan. USDA home loans are backed by the U.S. Department of Agriculture (USDA) and offer many benefits, including a zero down payment and reasonable closing costs.

One of the biggest benefits of the USDA loan program is that closing costs can be covered by a gift. That’s right – you don’t have to come up with any money out of pocket for your closing costs. In addition, there is no private mortgage insurance (PMI) required with a USDA mortgage. It should be noted that the USDA does require a monthly annual fee. But the monthly annual fee is less than PMI with a conventional loan and FHA loan.

Another benefit of a USDA mortgage loan is that the guarantee fee can be rolled into your loan amount, so you don’t have to pay it out-of-pocket. The upfront guarantee fee is similar to the FHA funding fee.

The USDA offers a few guidelines for home buyers when obtaining gift funds:

First, applicants must have a good credit score (640) and be able to provide documentation of their household income.

Second, the applicant must be able to demonstrate that the purchase is for their own use and not for selling or using the home as collateral.

To be eligible for the USDA Rural Housing Service mortgage, the applicant must either be an American citizen or permanent resident. They must also live or plan to live at the property that will be purchased through the grant or loan. It is also necessary that the applicant agrees to reside in the house for at least one (1) year following its purchase.

What is Gift Money?

Let's first look at what gift funds are. Gift funds are any monies that you receive from someone close to you, a relative, friend, or an employer for the purchase of your house. You receive the funds from the donor to pay the entire cost or at least a portion of it.

Satisfactory sources of gift money include the following:

  • Charitable organization
  • Labor union or employer
  • Family members
  • Homeownership Assistance Programs and Grants
  • Close friends may also be acceptable, depending on the mortgage lender.

What are the best ways to receive gift funds?

Parents signing a gift letter for sonThe USDA permits the receipt of gift money from a qualified donor(s) for closing and escrow costs if applicable, provided that the gift money transfer is properly documented.

With a recalcitrant donor, laying out a road map from donor to borrower can be torturous. The reason for detailed paperwork is to ensure that the gift money is not borrowed.

Gift money must be properly sourced:

To receive funds from the USDA or their lenders, there is a process that must be followed.

Donors who give gifts must provide a gift letter (provided by the lender). The gift letter to the borrower states that the money is not required to be returned/borrowed. The donor must also provide bank statement(s) to show he or she had enough money when the gift money was transferred into his or her savings or checking account.

A gift letter from a donor who provides money directly to a settlement firm requires the lender to verify that the money is not owing and that it was received by the settlement company.

Although a friend, relative or employer may offer you financial assistance, they cannot just give you a check.

Before you deposit the check in your bank account, make a photocopy of it.

You will need to deposit the check into the account you use for the withdrawal of funds.

A copy of your deposit slip should be kept for the lender.

A copy of your bank statement should be provided that shows the amount you have deposited.


How important is the gift letter?

The donor should also send a gift letter in addition to all the other steps. The letter serves as a declaration to the lender that the donor has received the following information:

  • Date of gift
  • The gift amount
  • Why the gift?
  • Address of where the funds will be used
  • It is important to note that these funds do not constitute a loan.
  • To complete the letter, the donor must sign it and date it.

Maintaining a record of donor contributions

The lender must still verify that the funds were originated from the donor, even if the donor signed the gift letter. The lender must verify that the donor did not borrow funds. Borrowers can hide their loan by asking a “donor” to take out the loan and give them the money.

The following documents can be used to prove the origination of funds:

To prove ownership, provide the last two months of bank statements.

Documentation proving the sale of an asset, such as a boat or car

Provide investment statements to accounts where they withdraw funds.

Steps to transfer money from donor to home buyer:

  1. The donor gives you the gift money in the form of a check. A cashier’s check is best.
  2. Make a copy of the check before you deposit it in your bank account.
  3. Deposit the check in the bank account that you’ll use to withdraw funds for closing.
  4. Keep a copy of the deposit ticket for the lender.
  5. Have a copy of your bank statement showing the deposit for the exact amount of the check.
  6. Don't touch the money!

Cash on hand is not an acceptable source of funds, since cash is difficult to track. Never accept cash as a source of gift money.

Additionally, lenders may have their own requirements for gift money. If in doubt, speak to your loan officer for further information.

What are the benefits of gift funds?

Gift funds can help cover closing costs and prepaid costs such as homeowner's insurance and per diem interest.

There are other ways to cover USDA closing costs

But what if gift money isn't available? What about closing costs? You still have options.

Seller Concession

The USDA loan program allows sellers' concessions to help borrowers who are struggling with closing costs. This is usually done when the actual home's value and the purchase price are equal.

When a home seller agrees to help with the buyer's closing and escrow costs, he or she can pay up to 6% of the home's sale price. Some sellers won't help at all, or they'll only agree to pay a lower percentage of the sale price.

The closing costs can be included in the home loan, provided the home appraisal exceeds the appraised value. The loan amount, including the guarantee fee, you are offered by lenders cannot be higher than the home appraisal.

Lender Assistance

Many lenders are able to cover all or most of the closing costs through premium pricing. The lender will cover these costs. The lender can increase the interest rate in exchange for no or reduced closing fees.

State and non-profit grants and loans

If you’re looking for a USDA loan, you may be able to get help from a grant or loan from your state or a non-profit organization. Some states offer programs that can help you with closing costs, and some non-profit organizations offer grants or loans for people who are looking to buy a home in a rural area.

If you’re interested in seeing if you qualify for any state or non-profit programs, you can contact your state’s housing finance agency or a local non-profit organization that specializes in rural housing.

Benefits of a USDA Loan

When you go to get a mortgage, there are several loan options available. One option is a USDA loan. A USDA loan is a mortgage option available to eligible homebuyers to buy a home. There are many benefits with USDA mortgages, which include the following:

– You do not need a down payment to qualify for the loan. This can be beneficial if you do not have the savings for a down payment or if you would prefer to use your savings for other purposes.

– The interest rates on USDA loans are typically lower than those of other loan types. This can save you money over the life of your loan.

– There are no monthly mortgage insurance premiums required with a USDA loan, however, there is a PMI like annual fee, although the cost is less than FHA loans  and conventional loans. VA loans do not require PMI or MIP.

Conclusion

Gift funds can be a great way for home buyers to purchase a home. The guidelines for the program are simple, and the process of applying is easy. If you are interested in purchasing a home, be sure to consider gift funds as a way to help you get into your dream home.

SOURCE: Chapter 9: Income Analysis

Recommended Reading

  1. Understanding the Underwriting Process for a Mortgage
  2. The USDA Loan: How It Can Help You Build Your Home
  3. USDA Loans: How to Use Seller Concessions to Your Advantage