When buying a home, the biggest upfront expense is likely to be the down payment. Even if future homeowners can reasonably afford monthly mortgage payments, the initial cost of purchasing a home may be too much for them to pay on their own.

That’s where a down payment gift comes in — if a close friend or family member wants to chip in and help the prospective homebuyer purchase a home, they can do so. However, there are strict rules and regulations for such a transfer of cash. Here’s what you need to know.

How does using gift money for a mortgage down payment work?

I see gift money becoming more popular, especially among millennials. Even if they make good money, because of large student loan amounts, it can be difficult for them to save for a down payment.

But this cost is often prohibitive, especially for first-time homebuyers who don’t have the benefit of funds from the sale of their current residence. 

You can use gifted funds to make a down payment, but your mortgage lender will want to know some details before they allow you to use it. Only two specific groups can give a home buyer money to fund their down payment.

Family members — as long as they can prove they have a standing relationship with the buyer. Sometimes the gift can come from a friend as well, but not all loan programs permit this.

Government agency, non-profit, or other organization offering down payment assistance — as part of a program meant to get first-time buyers into the market.

Can you pay back a mortgage gift?

The answer is no. This is considered mortgage or loan fraud, which is a crime. It can also put your loan qualification at risk as all loans need to be factored into your debt-to-income ratio.

Perito has seen borrowers tell the lender their parents are gifting the money, but it’s actually a loan. “They expect their kids to pay it back eventually,” she says. “That can cause a problem because the lender has to take that into consideration for the debt-to-income ratio.”

The moral of this story: Be honest with your lender about where you’re receiving all funds for your down payment — they’ll likely find out anyway.

What else should you know about down payment gifts?

As previously mentioned, there’s a difference between receiving a down payment gift and a down payment loan. Buyers need to be clear with their mortgage lenders and confirm that the money received was gifted. A sudden infusion of cash without a traceable source will leave lenders suspicious and, perhaps, wary of completing the loan deal on their end.

Plus, you should talk with your lender to make sure you are reporting the gift properly to the IRS. The responsibility for this is on the borrower and gifter, as lenders are not required to report it.

Tax implications of a down payment gift

As previously mentioned, family members have to pay a gift tax for anything over their limit of $16,000, or a collective $32,000 from parents who file taxes jointly. The person receiving the money doesn’t have to pay taxes.

If the donor wants to give more than $16,000, they can either pay taxes or claim the money as part of their $12.06 million lifetime exemption for gift taxes. However, this decision shouldn’t be taken lightly, especially if the donor hopes to pass on a hefty estate to their heirs later on. The $12.06 million exemption applies to taxes on these funds, so using up the value now could force family members to pay tax on whatever they inherit.

For borrowers interested in borrowing more without tax implications, there may be options involving separate gifts. Speak with a CPA if this applies to you.

Buying a home is more than a down payment

Ultimately, the cost of the down payment is only one expense to consider in the home-buying process. Homebuyers need to pay for closing costs, which include expenses like an appraisal, credit report, and underwriting fees.

“Many people these days have a hard time coming up with $1,000 to become a homeowner,” Perito says. “I always ask them where they’ll be getting money for the inspection, moving costs, and other expenses. I suggest to all my buyers that they have at least $4,000 in the bank before they buy a house.”

Down payment gifts can make it easier for homebuyers to afford a home

If you’re in the market for a new home and want a little help, don’t hesitate — just make sure you follow the above steps to ensure you accept such a gift in the proper manner. A gift can put homeownership in reach for plenty of aspiring homeowners.

When you speak with your lender about which loan program is best for you, be sure to let them know up front that you plan on using gift funds for the down payment. Some loan programs have strict guidelines about how much gift money you can use for a down payment and who can gift you the money.