USDA loans do not require a down payment. They allow 100% financing for an eligible property. However, there are closing costs a borrower must pay. If the borrower does not have them, they may use gift funds as long as they follow the USDA rules.
Gift Funds and Compensating Factors
The USDA does not allow gift funds to count as a compensating factor. A compensating factor is something that makes your application less risky. Let’s say, for example, you have a high debt ratio. The USDA allows debt ratios of 29/41. Let’s say your housing ratio was 30%. Rather than a lender turning you down, they may accept factors that make this less risky. The most common factor are cash reserves on hand. This is liquid money you have set aside that you can use to make your mortgage payment if your income stopped.
The USDA does not count any gift funds as cash reserves. The only exception to the rule is if you receive regular gifts from relatives or an employer. This may be a compensating factor.
Any sporadic funds you receive as gifts, though, may be used for other purposes, such as paying the closing costs.
Paying the Closing Costs
Many people mistakenly think they can automatically roll the closing costs on a USDA loan into the loan. While you can, it has to be under the right circumstances.
The value of the home must be greater than the purchase price. For example, if you signed a purchase contract for $150,000, but the appraiser says the home is worth $160,000, you may be able to roll the closing costs into the loan as long as they don’t exceed $10,000.
If the value of the home was $150,000, though, you would not be able to roll the fees into the loan. You would have to pay for them at the closing. This is where the gift funds may come into play.
Verifying a Gift
The first step in verifying gift funds is a Gift Letter. This is a letter from the donor stating the amount of money provided, the date, the purpose, and that it is a gift. It must clearly state that this is not a loan and that the donor does not expect repayment.
The donor must also provide proof of the transfer of the money. The easiest way is with a canceled check. The withdrawal must be from the donor’s personal account and the deposit must be made directly to the borrower. As the borrower, you must prove the deposit of the funds in your account with a deposit ticket.
Gift funds may come from a relative, employer, or charitable organization.
If you already received the funds before you applied for the loan, you will follow the above steps. If you don’t receive the gift funds until the closing, the closing agent or lender must verify that the above steps are satisfied. In other words, that the funds came from the donor’s own funds; that they are a gift and not a loan; and that the borrower deposited them into his own account.
Gift funds are not all that common with USDA loan simply because there is no down payment required. However, if a borrower needs help with closing costs, they can obtain a gift. Make sure you keep a paper trail and talk to your lender through every step. It is important that the funds are properly tracked so that they are not assumed to be another loan that you must repay. This could affect your debt ratio and your ability to secure a loan if that were the case.
Talk to your lender about the ability to accept gift funds and the process they require for the best results.