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Let's say you're ready to buy your first home -- but your bank account isn't. If you don't have the down payment money, loved ones are allowed to help.

But you'll need what's known as a "mortgage gift letter."

What's a mortgage gift letter?

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If you receive down payment money from a relative or friend, your lender will want to see a gift letter.

A mortgage gift letter is a form declaring that the down payment funds have been given to you as a gift.

It shows a mortgage lender that you're under no obligation to return the money.

The lender wants to know that when you agree to make your monthly home loan payments, you won’t face the additional financial stress of having to pay back the donor. That could make you more prone to falling behind on your mortgage.

Mortgage lenders prefer that you owe on your house to them and no one else. A lender may require your donor to provide a bank statement to show that the person had cash to give you for your down payment.

The gift letter may allow the donor to avoid paying a hefty federal gift tax on the transfer. Without the letter, the IRS could tax the donor for up to 40% on the gift amount.

Mortgage gift rules and restrictions

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Mortgage gifting has several layers of rules.

Note that the tax agency puts other limits on money gifts from one person to another. In 2018, a family member can give you up to $15,000 a year without any tax consequences. The lifetime limit is $11.2 million.

Amounts exceeding the limits are subject to the up-to-40% gift tax.

For conventional mortgage loans, a down payment gift generally must come from a family member. Anyone in a special relationship with the homebuyer — such as godparents or close family friends — must provide evidence of the relationship.

When making down payments of less than 20%, gift-recipient homebuyers must pay at least 5% of the sale price with their own funds. The remaining 15% can be paid with gift money.

Down payments exceeding 20% may be paid totally with gift money.

Low-down-payment mortgages and gifts

The rules can be a bit different with low-down-payment mortgages.

For example, VA home loans, available to active members of the U.S. military and veterans, require no down payment. But the borrower may choose to make a down payment — and it can come entirely from cash gifts.

USDA mortgages, offered to homebuyers in rural and some suburban areas, also do not require a down payment. As with VA loans, USDA mortgages allow the option of making a down payment, and all of that money can come from gifts.

FHA mortgages offer down payments as low as 3.5% and flexible mortgage benefits. With an FHA loan, mortgage down payment gifts can come from both friends and family members.

Remember that any gift requires a gift letter to reassure your lender that you don't owe the money!

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