A gift of equity can be a wonderful opportunity for a seller to help a family member purchase a home. It alleviates the need for a down payment and lowers the purchasing price of the home.
But how does a gift of equity affect the seller and the buyer? Let’s get into the benefits for both parties, as well as the important compliance requirements for the entire process.
What Is a Gift of Equity?
A gift of equity refers to a situation where someone sells a property for less than its fair market value. It involves the transfer of property ownership where the seller, usually a family member or someone else the buyer has a close relationship with, offers a portion of the equity in the property as a gift to the buyer.
The difference between the property’s fair market value and the sale price is considered a “gift” from the seller to the buyer. For example, if your property is worth $500,000 but you sell the property to a family member for $450,000, the gift of equity is $50,000.
The gift of equity needs to be properly documented through a gift of equity letter, as lenders typically require approval and documentation for these types of transactions to ensure compliance with financial and state regulations.
Regulatory Framework Surrounding Gift of Equity Transactions
Gifts of equity offer benefits for both parties, but they require strict adherence to specific regulations and guidelines, mainly those set forth by the Federal National Mortgage Association (FNMA), more commonly known as Fannie Mae.
FNMA gift of equity guidelines include:
Loan-to-Value Ratio
Fannie Mae has specific guidelines when it comes to the maximum loan-to-value (LTV) ratio for gift of equity transactions. The LTV ratio represents the percentage of the property’s value that the lender is willing to finance.
Gifts of equity may allow the buyer to qualify for a higher LTV ratio since a portion of the property’s value is being gifted.
Documentation Requirements
Fannie Mae typically requires thorough documentation of gift of equity transactions, including a gift letter signed by both the seller and the buyer.
The letter must clearly outline the amount of the gift, the relationship between the parties, and any conditions associated with the gift. The gift of equity letter should also specify that the funds are a true gift and not a loan that needs to be repaid.
Additionally, lenders also need to verify the source of the funds used for the gift of equity. This might involve getting bank statements or other documents to demonstrate that the funds are in fact available and were legally obtained.
Appraisal Requirements
Fannie Mae may require an appraisal to determine the fair market value of the property involved in the gift of equity transaction. This appraisal helps ensure that the transaction meets Fannie Mae’s underwriting standards and that the property’s value is accurately assessed.
Reporting Requirements
Lenders need to submit proper documentation to Fannie Mae or other regulatory authorities, and this includes the need to accurately keep records as well as establish procedures for documenting, tracking, and reporting the gift of equity transactions.
Relation to TRID and Truth in Lending
The Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA) integrate mortgage loan disclosures and settlement processes under the TILA-RESPA Integrated Disclosure (TRID) rule.
TRID aims to provide consumers with more transparent information about mortgage transactions and closing costs. Gift of equity transactions intersect with TRID and TILA in several ways:
- Disclosure Requirements: Under TRID, lenders are required to provide borrowers with detailed disclosures about their loan terms. This includes the source of funds for the transaction and any associated conditions that apply to the borrower.
- Loan Estimate and Closing Disclosure: Lenders also need to provide borrowers with a loan estimate, typically within three business days of receiving a loan application, and a closing disclosure, at least three business days before the loan closing. These disclosures include information about the loan terms, closing costs, and any funds being provided as a gift of equity.
- Compliance With TILA: TILA requires lenders to disclose the annual percentage rate (APR), finance charges, and other key terms of the loan. In gift of equity transactions, lenders need to make sure the loan terms and disclosures comply with all TILA requirements, including accurately reflecting the impact of the gifted equity on the loan terms.
In short, a gift of equity loan must adhere to FNMA/Fannie Mae guidelines. Since these transactions also intersect with TRID and TILA regulations, the accurate disclosure of the equity gift and compliance with loan disclosure requirements is an absolute necessity.
Guide to Disclosing Gifts of Equity
A gift of equity can take several forms. A parent can gift funds to a child to offset closing costs, or a seller can sell a property for less than the fair market value.
In the case of a family gift, the amount is disclosed as an “other credit” in the cost-to-close section of the loan estimate and the closing disclosure.
In the case of a sale for less than market value, there are various opinions on the proper method of disclosure. For example, compliance professionals often ask us whether the gift equity amount should be disclosed on the loan estimate in the calculating cash to close section as a seller credit or adjustments and other credits when the amount of gift equity is known at the time of initial disclosure.
We believe the safest approach is to disclose the contract sales price.
The instructions for the loan estimate and closing disclosure require the contract sales price to be disclosed as “sales price.” People purchasing a home for less than the fair market value prefer that the fair market value be shown as the purchase price since that higher number improves the loan-to-value ratio.
Using the higher number results in the gift of equity. The TRID regulations and related guidance don’t address the disclosure of this arrangement.
Other Compliance Considerations for Fannie Mae Gift Funds
Fair Lending Laws
Compliance with fair lending laws like the Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA) are a must when applying for a gift of equity mortgage loan.
Lenders need to make sure that gift fund policies don’t discriminate against borrowers based on personal characteristics. Simply put, all borrowers need to be treated fairly and equally during the entire process.
Anti-Money Laundering (AML) Regulations
Lenders need to comply with AML regulations by implementing Know Your Customer (KYC) procedures to verify the identity of the gift donor and to make sure that the gifted funds aren’t derived from illegal sources.
Consumer Financial Protection Bureau (CFPB) Regulations
Adhering to CFPB regulations, such as TILA and RESPA mentioned above, is an important element of the gift of equity process. Lenders need to accurately disclose gift funds on loan documents and comply with TRID requirements for transparent loan disclosures.
Compliance and Transparency With Gifts of Equity
Navigating the complexities of disclosing FNMA gift funds while maintaining compliance is paramount in the mortgage industry. By adhering to Fannie Mae guidelines and understanding how these transactions intersect with TRID and TILA regulations, lenders can ensure transparency and accuracy in their disclosures.
A thorough understanding of the requirements, coupled with diligent adherence to compliance measures, not only fosters trust and transparency but also mitigates risks for all parties involved.
As the regulatory landscape continues to evolve, staying informed and proactive in compliance efforts remains essential for a smooth and successful lending process.