FHA down payment sources: gifts, assistance and what the seller cannot pay

The minimum required investment

HUD's Handbook 4000.1 defines the minimum required investment as the borrower's contribution in cash or its equivalent, at least 3.5 percent of the adjusted value of the property. For purchases, the adjusted value is generally the lower of the price or the appraised value. Borrowers with a minimum decision credit score at or above 580 are eligible for maximum financing. Those between 500 and 579 are limited to 90 percent loan-to-value.

Your total cash needed is usually more than 3.5 percent, because closing costs and prepaid items come on top. Those extra costs can come from a wider range of sources than the minimum investment itself.

Acceptable gift donors

HUD allows gifts from:

• a family member;
• your employer or labor union;
• a close friend with a clearly defined and documented interest in you;
• a charitable organization; or
• a governmental agency or public entity with a program providing homeownership assistance to low- or moderate-income families or first-time homebuyers.

A gift of the minimum investment must also meet HUD's source rules described below. Cash on hand is not an acceptable source for a donor's gift. Gifts of equity, where a seller gives you part of the home's value, may only come from family members.

The gift letter and the paper trail

HUD requires a gift letter signed and dated by both the donor and you that includes the donor's name, address and telephone number, the relationship, the dollar amount and a statement that no repayment is required.

The lender must also document the transfer. Before closing, that can be the donor's bank statement showing the withdrawal with evidence of your deposit, a canceled check, a withdrawal receipt or an electronic transfer record. If the gift goes straight to closing, the lender needs evidence of a wire from the donor's account or a certified, cashier's or other official bank check.

What the seller and other interested parties cannot pay

HUD's handbook says the minimum investment must not come from the seller, from anyone else who benefits financially from the transaction, or from anyone who will be reimbursed by those parties. Additional funds to close may come from some of those sources if other rules allow it, but none of the 3.5 percent.

Interested parties, such as sellers, agents, builders and lenders, may contribute up to 6 percent of the sales price toward your origination fees, other closing costs, prepaid items and discount points. Contributions above 6 percent, or above your actual costs, are treated as an inducement to purchase.

Government assistance

HUD does not interpret the law to stop government entities, acting in their governmental capacity, from providing the minimum investment in some programs. State and local assistance is therefore a common source of FHA down payments. Check that the program is acceptable to your lender, and keep its approval letter.

The bottom line

The FHA minimum investment is at least 3.5 percent of the adjusted value with a 580 score or higher. It can come from your savings, an acceptable gift donor or a government program, but never from the seller or anyone profiting from the sale. Get a complete gift letter and a clean transfer trail.