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All in the Family: How Relatives Can Help with Home Buying
Although the national homeownership rate has climbed steadily over the past year, reaching its highest level in almost 15 years, affordability still remains a major barrier for millions of Americans. Many potential home buyers find that even if they can afford the monthly mortgage payments, they have difficulty accumulating enough money to cover the down payment and closing costs.

So where can home buyers go for help? Increasingly, the answer may be their families. The trend toward using relatives as a financial resource is growing rapidly, according to mortgage lenders, homeowner advocacy groups, and others connected with the mortgage industry. This increasing reliance on family members is partly a reflection of home buyers' mounting difficulty in saving for the down payment. But, it also stems from continuing efforts by government and private industry groups to make homeownership easier through gift programs allowing buyers to use funds from a variety of sources.

Both Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation) have made their guidelines governing gift-giving more flexible. The Fannie Mae Community Homebuyer's 3/2 Program and the Freddie Mac Affordable Gold Program allow home buyers to make down payments of only 5 percent, with 3 percent coming from the borrower's own funds and the remaining 2 percent from gifts, grants or loans obtained from a relative, church, municipality, nonprofit organization, or even employer.

In certain situations, Fannie Mae and Freddie Mac will allow the entire 5 percent down payment to come from a gift source. This is permitted when the relative providing the gift has lived with the borrower for the last 12 months. If a live-in relative furnishes the gift, this individual must also provide documentation demonstrating shared residency. The home buyer will also need to purchase mortgage insurance, since these low down payment programs require less than the standard 20 percent down.

Here are some additional options currently available to home buyers seeking assistance from family members.

Cash Gifts

If home buyers plan to make a down payment of 20 percent or more, their relatives can provide the entire down payment. If, however, the loan-to-value ratio of their loan exceeds 80 percent (meaning the down payment will be less than 20 percent), most lenders will require that home buyers contribute at least a 5 percent down payment from their own verifiable funds. The remainder of the down payment can then come as a gift. One caveat: Because individual donors of gifts over $10,000 must pay a gift tax, many relatives will be reluctant to make gift payments over that amount.

Financial gifts from relatives must be accompanied by several documents. These include a gift letter specifying the amount and purpose of the gift and stating that no repayment is expected, a letter demonstrating proof of delivery of the funds, and documentation from the bank confirming that the donor has sufficient funds to provide the money. 

The best form of documentation is a certified personal check or cashier's check from the family member to the buyer. Whatever the form of payment, the gift funds must be received in the borrower's account before closing. The borrower's mortgage lender must also be able to trace the flow of gift funds from the donor's account to the buyer's account, through deposit slips, bank statements, and other documentation.

Pledge Loans

Many lenders offer programs that enable prospective homebuyers to benefit from pledged financial support or cash gifts from relatives. Gift programs allow relatives to subsidize home loans via cash gifts that do not have to be repaid. Other programs permit relatives to deposit money into a special collateral account that is pledged as security for the borrower's mortgage loan. Should the borrower default on the loan, the pledged financial support can be used to repay a portion of the lender's foreclosure costs.

For most of these programs, borrower contributions of 3 % of the purchase price are preferred. Of this amount, a minimum of $1,000 is required to be paid by the borrower in the form of either a down payment or closing costs. The borrower must also have at least two months' cash reserves after the loan closing. And the pledge or gift amount must be sufficient to reduce the uncollateralized portion of the loan to an amount either equal to or less than 90% of the property value.

Co-signing for the Loan

If a buyer's relatives don't have sufficient assets to make a gift payment, they can still help by co-signing the loan. Assuming the co-signers' financial standing and credit are adequate, their written guarantee will enable the borrower to qualify for a mortgage he or she might not otherwise be able to obtain. However, this option has its dangers: If the borrower reneges on the loan, the relatives will be responsible for continuing the monthly mortgage payments. But since they are not listed on the deed, co-signers will have no equity in the home. Thus, relatives could incur a significant financial burden without receiving a financial payoff.

Equity Sharing

This arrangement provides relatives with more control over the property than either a gift program or a co-signing agreement. Under equity sharing, family members make an investment in the home and are named on the deed as co-owners. When the house is eventually sold, they receive a portion of the sales proceeds (the net of any liens or encumbrances), based on their percentage of the investment. Because equity sharing provides relatives with an actual ownership interest in the property, it is often preferred by parents or other family members who contributed a significant amount towards the borrower's down payment.

But equity sharing also has its downside: Many lenders will add the principal, interest, tax and insurance payments for the borrower's home to the relative's debt load. This could make it difficult for co-signers to secure credit to buy a new home or investment property of their own.

Buying Down the Interest Rate of the Loan

Buy-down assistance enables buyers to make lower mortgage payments in the early years of the loan and then increase them incrementally as their financial situation improves. In the typical two-year buy-down (known as a two-one buy-down), family members contribute 2 to 3 percent of the loan amount. This money is held in an escrow account, allowing the buyer to make reduced mortgage payments for a period of two years. Another advantage is that the borrower qualifies for the mortgage at the first-year payment level rather than at the true interest rate.

For example, if buyers applied for a fixed-rate $100,000 loan with an 8 percent interest rate, and their relatives contributed about $2,500, they would pay 6 percent the first year and qualify at that rate. The rate would increase to 7 percent after the first year, and remain fixed at 8 percent from the end of the buy-down until the loan is paid off.

Gifts of Equity

Instead of a cash gift, relatives may opt to give family members what's known as a gift of equity. Here's how it works: A parent or other relative decides to move to another residence and agrees to sell his or her home to a family member. The relative wouldn't want to give away the home outright because of the taxes that would be incurred. But he or she may be willing to sell the house at a price well below market value -- $150,000 instead of $200,000, for example. Because the relative is essentially giving the recipient the difference between the true value and the selling price, the buyer is able to afford a more attractive home than would otherwise be possible.

The buyer must still obtain a mortgage and make a down payment, but the mortgage will be significantly lower because it will be based on the lower sales price, rather than the higher appraised value. The sellers may also have to pay a gift tax, depending on how much they discounted the price of the home, but the amount will be much less than if they gifted the entire value of the home.

Loans

Arranging a home loan from a relative may initially appear to be easier than asking for a gift, but it can be far more complicated. Because a loan must be repaid, lenders will add its market value to the borrower's total debt ratio. This could make it difficult for buyers to qualify for a mortgage in the first place. And since many lenders require that loans be secured by an asset -- often the property itself -- the total amount leveraged against the house could also increase. Again, this could have a negative impact on the borrower's ability to secure a loan.

Understanding the many kinds of assistance that relatives can provide will enable potential home buyers to become smarter shoppers when applying for a mortgage. If they do their homework, borrowers may find that purchasing a home can be a successful, enjoyable and even profitable family affair.