In a Purchase Transaction, What Is a Gift?
January 21, 2002, Revised September 4, 2007
When borrowers receive cash from relatives to help buy a house, lenders insist that the assistance be a gift rather than a loan, since the repayment obligation on a loan could weaken the borrower's capacity to repay the mortgage. There are circumstances, however, as illustrated by the letter below, in which the relative can make a loan in a form which which meets the lender's concern, which might therefore justify the relative declaring it as a "gift".
“My brother and his wife are in a bind. They are about to close on a new house, but the old one has yet to go under contract. We have the available funds to loan them the down payment, which will be easily repaid from the equity in the old house when it does sell. The mortgage broker on the new house is requiring that we sign a 'gift letter' stating that the down payment is a gift. It is not. Should we sign the gift letter to make the lender happy, even though we will be repaid when the house sells?”
This is essentially an ethical decision that I can’t make for you. However, the ethical issue may not be exactly what you now think it is.
Since you intend to be repaid on the sale of your brother’s house, it appears that you are making a loan rather than a gift, and therefore signing a gift statement is a lie. But before jumping to that conclusion, lets consider what constitutes a gift in the lender’s eyes.
To the lender, a gift is a transfer of funds to your brother that imposes no repayment obligation that could put the mortgage loan at risk. Suppose the value of your brother’s old house drops so sharply before it is sold that the remaining equity is less than the amount you advanced. Then if the transfer is a loan, your demand to be repaid could jeopardize your brother’s ability to pay his mortgage. The lender does not want to take that risk.
On the other hand, if proceeds from sale of the house are sufficient to cover the amount you advanced, the repayment to you doesn’t endanger the mortgage loan. In that situation, the lender doesn’t care if you get the money back.
This leads to the following definition of “gift” in your case. If you are prepared to be repaid only when your brother sells his house, and only for an amount that does not exceed the equity realized in the house, then you are indeed making a gift in the sense that matters to the lender. You can sign the gift letter in good conscience.
On the other hand, if you expect to be repaid in full even if the amount realized on the sale falls short of the amount you advance, the advance is not a gift. Signing the gift letter would deceive the lender.
If you do want to be repaid but don’t want to be deceitful, suggest to your brother that he take out a home equity loan, which he can repay when he sells his house. This is what most other homebuyers do in this situation.
In addition to not placing you in an awkward position, a home equity loan avoids a hazard that you may not have considered. The interest rate on the home equity loan includes a “risk premium” to cover the possibility of default. The interest rate you charge is lower because he is your brother and you are confident that he will repay you. Yet the fact is that you are taking a risk.
Your loan is unsecured. If God forbid your brother dies before you are repaid, are you sure his wife will recognize his obligation to you? Or worse yet, suppose they are both killed in an automobile accident. Then you would have an unsecured claim against their estate, and might end up getting little or nothing.
Bottom line: it would be best all around if your brother took out a home equity loan.
When borrowers receive cash from relatives to help buy a house, lenders insist that the assistance be a gift rather than a loan, since the repayment obligation on a loan could weaken the borrower's capacity to repay the mortgage. There are circumstances, however, as illustrated by the letter below, in which the relative can make a loan in a form which which meets the lender's concern, which might therefore justify the relative declaring it as a "gift".
What Is a Gift?
“My brother and his wife are in a bind. They are about to close on a new house, but the old one has yet to go under contract. We have the available funds to loan them the down payment, which will be easily repaid from the equity in the old house when it does sell. The mortgage broker on the new house is requiring that we sign a 'gift letter' stating that the down payment is a gift. It is not. Should we sign the gift letter to make the lender happy, even though we will be repaid when the house sells?”
This is essentially an ethical decision that I can’t make for you. However, the ethical issue may not be exactly what you now think it is.
Since you intend to be repaid on the sale of your brother’s house, it appears that you are making a loan rather than a gift, and therefore signing a gift statement is a lie. But before jumping to that conclusion, lets consider what constitutes a gift in the lender’s eyes.
To the lender, a gift is a transfer of funds to your brother that imposes no repayment obligation that could put the mortgage loan at risk. Suppose the value of your brother’s old house drops so sharply before it is sold that the remaining equity is less than the amount you advanced. Then if the transfer is a loan, your demand to be repaid could jeopardize your brother’s ability to pay his mortgage. The lender does not want to take that risk.
On the other hand, if proceeds from sale of the house are sufficient to cover the amount you advanced, the repayment to you doesn’t endanger the mortgage loan. In that situation, the lender doesn’t care if you get the money back.
This leads to the following definition of “gift” in your case. If you are prepared to be repaid only when your brother sells his house, and only for an amount that does not exceed the equity realized in the house, then you are indeed making a gift in the sense that matters to the lender. You can sign the gift letter in good conscience.
On the other hand, if you expect to be repaid in full even if the amount realized on the sale falls short of the amount you advance, the advance is not a gift. Signing the gift letter would deceive the lender.
A Home Equity Loan on the Existing House May Be Better For Everyone
If you do want to be repaid but don’t want to be deceitful, suggest to your brother that he take out a home equity loan, which he can repay when he sells his house. This is what most other homebuyers do in this situation.
In addition to not placing you in an awkward position, a home equity loan avoids a hazard that you may not have considered. The interest rate on the home equity loan includes a “risk premium” to cover the possibility of default. The interest rate you charge is lower because he is your brother and you are confident that he will repay you. Yet the fact is that you are taking a risk.
Your loan is unsecured. If God forbid your brother dies before you are repaid, are you sure his wife will recognize his obligation to you? Or worse yet, suppose they are both killed in an automobile accident. Then you would have an unsecured claim against their estate, and might end up getting little or nothing.
Bottom line: it would be best all around if your brother took out a home equity loan.