A gift of equity occurs when the seller of a home sells it for less than its current market value, leaving a cash cushion that can be used as part of the buyer’s down payment. This type of transaction often happens between family members, such as parents selling their home to their children. It also may occur between other close contacts if it’s in line with mortgage lender requirements. However, the rules for gift of equity vary by mortgage lender and sometimes by property types.

To execute a gift of equity, the seller hires an appraiser to determine the home’s value and then agrees to sell it for less than that price. The amount of the difference between the appraisal value and the sale price is considered the gift of equity. The seller must document the equity gift by including a letter in the sale agreement and providing another at closing. This letter must state the specifics of the relationship between the sellers and buyers as well as the value of the gifted equity.

The buyer must complete all of the other loan requirements for the mortgage, including making a down payment and meeting credit and income guidelines. However, the down payment requirement can be a smaller amount than that required for conventional loans, and this is one of the biggest benefits of a gift of equity for first-time buyers.

Buyers can save on upfront costs, such as the real estate commission and legal fees, by using a gift of equity to purchase a home. They can also save on monthly PMI expenses by covering the full down payment with a gift of equity.

Both parties involved in the transaction must meet all of the mortgage lender’s requirements, and there may be additional guidelines that the parties must follow to document the gift of equity. For example, some lenders require that the parties have a certain relationship or that the sale of the property take place in a particular neighborhood. They may also have to meet income and credit guidelines, and both the seller and buyer must sign the gift letter.

There are also some tax implications to consider, and it’s recommended that you speak with a tax professional before proceeding with this type of transaction. For example, there’s a maximum dollar amount you can give that doesn’t trigger a gift tax (currently $15,000 per individual). But any amounts given beyond that will require the parties to file an IRS Form 709.