With the increasing prices every day, buying your dream house has become, well, just a dream. Many people find it hard to make ends meet, and even paying rent can be difficult. Some luckily inherit family homes or properties from relatives, but that’s not the case with everyone. However, buying your first home might become more accessible with a gift of equity. Do you know what it is? Keep reading to learn all about the gift of equity.

What is Gift of Equity?

When a homeowner sells their house to a close loved one at a price lower than the property’s market value, it is called a “gift of equity”. Usually, gifts of equity are transactions between family members. For example, from parents to their child or the grandparent to grandchild.

By selling the property to a family member for a lower price, homeowners can keep the house in the family at a comparatively low cost for both parties. This way, the buyer gets to take out a mortgage on a reduced amount than the market value of the home. And for the lenders, the difference in value is perceived as a kind of down payment. By the end, the seller can pay off the final portion of the mortgage. As for the buyer, they’re left with monthly mortgages that are more affordable than if they had bought the house at a full market value.

Pros of Gift of Equity

Apart from keeping the property in the family and making it easier to buy your first house, the gift of equity also has other benefits. These include:

  • Home Equity for the Buyer: Making the purchase will come with immediate equity for the property you buy. This means you can take out home equity loans to upgrade your home a bit, pay off the remaining debt, or make other purchases.
  • Saving on Upfront Costs & PMI: This allows the buyer to top up their down payment or pay it off entirely. Plus, they can avoid paying PMI and probably apply this gift to other closing costs.
  • Accessible Homeownership: You won’t have to save up for a down payment with the gift of equity. Instead, you will have a more financially feasible alternative to becoming a homeowner.
  • Saving on Real Estate Commission: Since the transaction usually takes place without an agent, the seller gets to save on the real estate commissions.

Cons of Gift of Equity

Gift of equity is not all sunshine and rainbows; it has its drawbacks too. Some of these include:

  • Possible Gift Tax: The seller might have to pay a gift tax if the gift of equity exceeds the annual exclusion.
  • Potential Capital Gains Tax: If the buyer sells the house eventually, they might have to pay a higher capital gains tax. Since the gift of equity lowers the cost basis, you might have to pay increased taxes if you have a sufficient profit when selling the house.
  • Eligibility: The buyers and sellers need to have a specific relationship for the gift of equity, as the lender requires. Moreover, there are restrictions on the property as well.
  • Legal Fees: You’ll be free from paying the real estate commissions. Still, you’ll need to pay a lower to help you manage this transaction.
  • Limitations: Gift of equity is less flexible than a cash down-payment gift, as it is tied to a specific property.

What’s the Takeaway?

In conclusion, a gift of equity can help you buy your first house at a lower price than the property’s market value. It has many benefits, but some disadvantages as well.
We offer loan programs at Red Door Funding; contact us today at (832) 539-1099 for more information.

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