A gift of equity happens when a relative sells you their home for less than it's worth and gives you the difference. The lender treats that difference like a cash gift, so it can cover your down payment and often your closing costs, even if you bring very little from your own savings.
Picture a parent whose home appraises at $300,000. They sell it to their daughter at that value and give her $30,000 of their equity at closing. On paper the price is $300,000, the gift is $30,000, and she borrows the rest.
How FHA and Conventional loans treat it
FHA. HUD allows a gift of equity only from a family member selling to another family member. The equity can satisfy FHA's minimum required investment, the 3.5% down payment at a 580 score or higher, so the buyer may not need any cash for the down payment at all.
Conventional. Fannie Mae accepts a gift of equity from an acceptable donor, such as a relative, on a principal residence or a second home. It can pay all or part of the down payment and closing costs, including prepaids, but it can't count toward reserves. The usual gift rules still apply, so on a 2 to 4 unit home with less than 20% down, you put in 5% of your own money first.
Both programs want a signed gift letter stating the dollar amount and that it isn't a loan. The settlement statement at closing lists the gift of equity as a credit to you.
A worked example on a $300,000 home
Here's that daughter buying with FHA. Compare her loan with the $30,000 gift to a standard 3.5% down purchase of the same home with no gift.
| 3.5% down, no gift | $30,000 gift of equity | |
|---|---|---|
| Cash for the down payment | $10,500 | $0 |
| Base loan | $289,500 | $270,000 |
| Loan with 1.75% upfront MIP | $294,566.25 | $274,725 |
| Principal and interest at a 5.75% rate | $1,719.01 | $1,603.22 |
| Annual MIP, monthly | $132.69 (0.55%) | $112.50 (0.50%) |
The gift saves her $10,500 in cash and $135.98 a month ($115.79 of principal and interest plus $20.19 of mortgage insurance). Because her loan-to-value sits at 90%, FHA's annual premium ends after 11 years instead of lasting the life of the loan.
Setting up a family sale
Agree on the price and the gift amount before the contract is signed, so the gift letter, the contract and the appraisal all line up. If the relative selling still has a mortgage, the price has to cover their payoff plus their own closing costs, which limits how large the gift can be.
The cash to close calculator shows what's left for you to bring once the gift is counted. For help setting up a family purchase so the lender accepts every piece of it, call AAA Capital Funding at 888-601-8344.