Gift of Equity: The Right Way to Structure a Family Home Sale

A parent wants to sell the house to their son. The house is worth $500,000. The parent says, “Hey, I’ll knock $100,000 off for you.” Everybody shakes hands on $400,000. It sounds simple. It is the setup for one of the most common ways a family sale falls apart at the closing table.

Gift of equity is not something most people do more than once in their lives. Most loan officers do not see one very often either. So the deal gets put together by people who are doing it for the first time. That is where it goes wrong.

We did a full episode on this on The South Florida Mortgage Report. Here is the short version, with the numbers.

What a gift of equity is

Someone owns a home. They want to help a family member buy it. Usually it is a child or a grandchild. They are not giving away every dollar of equity. They want some money out of the house. But they are willing to give part of the equity to the buyer.

That gifted equity does the job a cash down payment would normally do. And it can cover the buyer’s closing costs too, as long as there is enough equity in the house.

Done right, the buyer gets in without having saved up a down payment, and the seller walks away with exactly what they wanted.

How it goes wrong

Here is the version we have seen more than once.

The house is worth $500,000. The parent owes $170,000 on it and wants $230,000 out. They agree to give their son $100,000 off. In the parent’s mind, the son is buying the house for $400,000. In the son’s mind, he is getting a $500,000 house for $400,000. Great.

So the son goes to a lender. “Hey, I’m buying a house for $400,000 and I’m getting a $100,000 gift of equity.” The lender says, “OK, get me a contract and a gift letter.”

The contract comes back at $400,000. The gift letter comes back at $100,000. The lender sets up a loan around those two documents. The seller usually is not talking to the lender at all. Usually there is no real estate agent. Nobody is looking at the whole picture.

Then everybody gets to the closing table. And the seller says, “No, no, no. I’m not selling for $400,000 and giving you another $100,000. That was already baked in.”

The $100,000 discount was already in the $400,000 price. The gift letter counted it a second time.

Now the person who was generously trying to help is not getting what they were told they would get. And the deal has to be redone.

The right way: stack up the money first

Start with a simple idea. One person wants money out of this deal. The other person does not want to bring money in. If the buyer brings nothing and the seller takes money out, then all of the money in the deal comes from one place. The lender.

So add up everything that needs to come out of the deal. That total is the loan.

Then set the price at the full value. $500,000. Not $400,000.

This part feels backwards to people. The family wanted to “give a discount,” and now the contract shows the full price. But the price needs to be set at the highest value. That is how the buyer gets the maximum equity benefit when they close.

The gift letter is the difference. On this deal it is not $100,000. It works out to $92,500, because the seller’s closing costs come out of what they are giving, and the buyer’s closing costs get covered by it.

And when there is even more equity in the house, the loan can land at 80% of the value or less. Then there is no mortgage insurance at all.

What that looked like for one of Bill’s clients

My co-host Bill Mei had a past client he has known for more than twenty years call him with exactly this. The client bought his house in 2008 for about $200,000. It was worth about $450,000. He wanted to sell it to his daughter and her husband and move somewhere smaller. They did not have much money saved, so the plan was an FHA loan with a small down payment.

Bill stopped him. “Hey, are you familiar with gift of equity?”

A friend of theirs who is a realtor had already pulled the comparable sales, so everybody had a good idea what the house was worth. We plugged the numbers into the spreadsheet. With that much equity, the daughter could go conventional, at a low loan-to-value, with no mortgage insurance. Once the family saw it laid out, it made sense right away.

The number that matters most

On a regular sale, the seller has an agent watching their net. On a family sale, the lender is often the only one in the deal who has done this before.

What the seller wants to walk away with is the most important number in the deal.

So hear it from the seller directly. Not secondhand through the buyer. Sometimes there is miscommunication between the buyer and the seller about it, and the closing table is the worst place to find out. Get it right up front and the deal gets done once instead of twice.

Who can give a gift of equity

It is a gift, so it follows the gift rules. On the normal loan programs, conventional, FHA, VA, only certain people are acceptable donors. Usually that means family.

A seller who is not related to you is not an acceptable donor. This is not a way to get a discount from a stranger and call it a gift.

What about taxes?

The question comes up every time. Is the seller going to owe tax on the gift? There are annual gift limits and lifetime limits, and how they apply depends on the family.

Talk to your tax accountant before you sign anything.

What to do with this

A really good way to set somebody up

When it is done right, everybody wins. The buyer gets a home with real equity on day one. The seller gets the money they planned on. And a parent or grandparent gets to give a gift that is not wrapped.

It needs an attorney or a title company that knows how to handle it, and a lender who puts the full numbers in front of both sides before anyone signs. That is the whole difference between doing this once and doing it twice.

We talk through this kind of thing every week on The South Florida Mortgage Report.

Capital Partners Mortgage Services, LLC · NMLS #2332376 · Craig Garcia, NMLS #653593 · 1515 N. University Dr., Suite D102, Coral Springs, FL 33071 · Equal Housing Opportunity · NMLS Consumer Access: www.nmlsconsumeraccess.org
Educational information only. Not a commitment to lend or an offer of credit, and not investment, tax or legal advice. The figures in this post are a hypothetical example used to illustrate how a gift of equity transaction is structured; they do not represent a loan offer, and actual closing costs, mortgage insurance and eligibility depend on the property, the program and the borrower. Gift of equity eligibility, acceptable donors and documentation requirements vary by agency, program and investor and are determined in underwriting. Consult a qualified tax professional regarding gift tax. All loans are subject to credit, income, property, appraisal and program approval.