“with the least taxable consequences to him.”…………….”avoid PMI”
Remember the teenage years when we’d be with a group of friends at the movie theater and after a period of darkness someone would yell out, “hand check!”? Okay, so “reality check!” I can tell you straight up, both of you are in dreamland. I suspect it was the legal representation that got you to this state too. So be aware that I’m not insulting anyone’s intelligence here. Far from it. Lets see if we can wake you up and bring you back to today’s reality.
Let’s start with a bit of my background, in the hopes it helps you know where I’m coming from. Over my lifetime thus far I have purchased 4 properties and assisted my son with the purchase of his first property. I also have a family member (my mother) who worked for 35 years in the banking industry, with the last 20 or so as a loan officer. Through her I have learned quite a bit about the industry, with the bulk of my knowledge being in the purchase of investment rental property with borrowed money. So while I’m not formally trained or educated in financial law, I do consider myself just a tiny bit more knowledgeable on the subject than your average first time home buyer. But still, I do not consider myself to be “authoritative” on this subject, by any stretch of one’s imagination.
First, it’s necessary to understand just exactly what a gift is, from a tax perspective, and from the IRS’s perspective. Let’s begin with that IRS Form 709 – Gift Tax Return. The name of that form is a misnomer. There is no such thing as a “gift tax” that one pays per-se –unless the gift exceeds $5.2M, which is not what I would call “common”. But the reason a gift tax has to be filed by the giver of a gift valued at more than $14K, is because that amount is then subtracted from their inheritance non-taxable and non-reportable ceiling value of $5.2 million dollars. So even though the value of the gift may be more than $14K in any one tax year thus requiring the form 709 be filed by the giver of the gift, they will not be paying any additional “gift tax” on top of any other taxes they already paid when they originally earned that money.
When a bank or other lender loans money for the purchase of real estate, they basically hold claim to that real estate as collateral for the amount borrowed in the form of a lien. Commonly, lenders will loan a maximum of 80% of the property’s appraised value. But that percentage can be higher based on other factors such as your income, past financial stability, your current outstanding and recurring debts, and what that lender perceives as your “ability to pay the loan back.” In essence, the lender is taking a risk, regardless of what that level of risk may be, that they may not only lose money on this deal, but lose their “investment” into your purchase of the property. Once that borrowed money is paid to the seller and the deal is closed, that’s it. Under no circumstances can they go back and repossess that money from the seller. They can only repossess it from the borrower, either over time as agreed upon in the loan contract, or through foreclosure on the property if the loan contract is breached by the borrower.
As an outrageous example of this risk, if 2 months after you close the deal a meteor hits the house and destroys it, leaving a radioactive crater 50 foot deep and 100 feet in diameter, your property insurance doesn’t cover meteor strikes. So the home is gone and the land is radioactive for the next 10,000 years making it uninhabitable and unusable. You are also not going to continue payments for a home that no longer exists, and will never be rebuilt in your lifetime. Now the bank can take you to court if they want and “sue you” for the money you owe. They can (and probably will) win such a suit. But you can’t get blood from a rock. Bottom line is, the bank took that risk and lost. So in the end, they will end up writing off that loss and pressing on with life and business. If they want to foreclose on a radioactive homesite that now has zero value, they’re welcome to it.
Now with that outrageous example above, the bank only loaned you 80% of the value. They expect you to have the remaining 20% (or whatever the percentages may be – I’m just picking numbers out of thin air here) of *your* money in this deal too. This way, the lender is not the only one with “skin in the game” so-to-speak. So when it comes to dollar figures, they just have more of their skin in that game than you do. But percentage-wise, you actually have more to lose in this scenario than the bank does. The lender has millions, if not billions of dollars in other investments that are making them money. The loss of one of those investments is barely a “blip” on the screen to them. But for you, the loss of your down payment in my above scenario which will never be recovered is more than just a fist up side your head for you. Your loss is devastating to you and it could take you years to recover if you can actually recover at all. Meanwhile, the lender’s loss is barely a blip on the radar screen.
Now when you apply for a loan one thing you’re required to do is provide the perspective lender all your financial data, as well as financial history. They’re looking for stability. They’re also looking for where your down payment (your “skin in the game”) is coming from and they expect to see a realistic history of just how you got it.
So if their pull of your financial history shows you had an average of $2,500 in your checking account each month over the last few years, and then two months ago there’s this large $40,000 deposit, you got some ‘splainin’ to do.
“I borrowed it from my brother” will be followed with a request for the loan documents from your brother. If no such document exists, your loan application is disapproved.
“My brother and his wife gave it to me as a gift” will result in an IRS pull for all form 709’s with your name on them as the recipient. If there are none, your loan application is disapproved. If the gift amount from each giver is less than $14K thus not requiring the 709 to be filed, the lender will want at a minimum, a notarized statement from each gift giver that is is “in fact” a gift, and in that statement they must permanently relinquish any and all claims to it forever. Usually, the lender requires they be the ones to notarize their statement also, if the gift giver lives in the local area. But remember, even with a proven gift of the down payment, the lender may still disapprove your application because the fact is, *you* don’t have any “skin in the game” so-to-speak.
Generally when someone gives you a gift, especially a monetary gift, it’s money that giver has acquired one way or another and paid taxes on it already; be it regular income tax, capital gains tax, gambling winnings tax, or whatever. The only exception would be if it was money the giver inherited. But for the most part, “someone” has at some point, already paid tax on that money prior to it being gifted to you. My point here is, your family member cannot gift you what they don’t already have in their physical possession or control prior to their sale of the property. I’ve heard it all from mom, and can tell you for a fact it won’t work.
Lending laws, rules and regulations are tighter and stricter than they have been over the last 35 plus years my mother has been in the industry. I can tell you with a high degree of confidence that if my mother read your post, her response would be, “Not in my bank.” But never say never. I always say where there’s a will, there’s a way.
Start by living well below your means. Cut up the credit cards and just keep making the payments. When it comes to credit cards my view is, if I didn’t have it yesterday then why do I need to spend this money and buy this item today? Is my world going to end if I don’t?
Next, start pumping every spare penny you can into savings. You want to show the perspective lender a history of this. I would expect 3 to 6 months of aggressive savings would do it. You can start by cutting the cable bill down, as well as the cell phone bill and that internet bill. Increase the deductible on that car insurance from $100 to $1000 to reduce that insurance by about $250-300 a year, and add that difference to your savings. There’s all kinds of places where you can cut back, if you just put your mind to it. We’re not talking about doing this for the rest of your life now. You’re just trying to qualify for the loan.
Now here’s where the “trick” comes into play, and the best part is if it fails, then that failure falls on the family member selling you the property, and not you. After you have been aggressively saving for say, 5 months or so, that family member wanting to sell you the property takes out a HELOC on that property for the amount they’re going to gift you. They gift it to you and file the 709’s with the IRS. Let the gift sit in your bank account for at least a month. During that month it will earn you a bit of interest, but that time is needed so the transaction will show up in your financial history when the lender pulls it.
Now, if your loan application is approved you’ll make the down payment, close the deal and your family member gets their money for the sale. The first thing they pay off is the HELOC of course, along with their outstanding balance on their original mortgage on the property. (actually, both will be required to be paid off as a part of the deal at the closing on the sale of the property to you.) If this flies, that takes care of the gifted money legally, and everybody walks away happy. But of course, the seller will have a few bucks less in their pocket because of the two or three months of interest they had to pay on the HELOC.
Now lets talk about avoiding PMI without having to have such a large down payment. For the bank, PMI only covers the down payment, and that’s it. So if the minimum down payment to avoid PMI is $120,000 (that’s 20% of $600K) and you only have say, 60K to put down, you’re going to be paying PMI. Should something happen to you the borrower before 20% of the property value is paid off (which would then eliminate the PMI), the insurance company providing that insurance will pay the bank no more than 20% of the property value, thus guaranteeing the bank that they will get “at least” 20% of the property value back straight up.
So, do you and the spouse have life insurance policies? I can tell you right now that for the coverage, the cost of Private Mortgage Insurance is at least ten times more than the cost of life insurance when compared dollar to dollar for the payout amount. Talk to the loan officer about making the lender the sole and primary beneficiary of your life insurance policies until such time that you have exceeded the threshold where PMI is no longer required. Now it usually depends on the specific loan officer you’re talking to, and how willing they are to do that dirty, filthy, unspeakable four letter word and “WORK” for their money. I have personally seen this work for people.
Say you need $120K minimum down payment to avoid PMI, but you only have $60K. If you and your spouse each have a $100K life insurance policy, offer to make the lender primary beneficiary on those policies until such time PMI is no longer required. While I would not be shocked if they didn’t take that deal, I would be mildly surprised. Here’s why.
If you put $60K down and a year later you and the spouse die in a car accident, the PMI provider is only going to pay the bank the other $60K minus the payments you’ve already made in that first year. Whereas if you and the spouse each have a $100K life insurance policy, the bank is going to receive $100K if one of you dies, or $200K if both of you die, immediately reducing the loan balance (if not eliminating it by paying it off completely) Johnny-on-the-spot. If per state law this setup is legal in your state, any loan officer that would turn that down is definitely not well versed in alternative loan techniques.
Back in the 90’s while in the military and stationed in Hawaii, I personally witnessed an E-3 barely making $1200 take-home pay a month use this technique to purchase a $300,000 house and lot in Hawaii. He put a mere $3000 down (1%), made the bank primary beneficiary on his $200,000 SGLI (Servicemans Group Life Insurance) policy and go the loan. For the three years he was there he rented the property out for about $300 more than the monthly payments. A few months before leaving Hawaii for his next assignment he sold the property for around $450,000, paid off the remainer of the loan, pocketed just over $150,000 and left the state for his next assignment right after changing the beneficiary on his SGLI back to whoever he wanted to. What amazed me, was this guy was a single man with a rank of E-3 who based on his income level, actually would have qualified for food stamps at the time in that state, were he not military! So think outside the box, and you may surprise yourself. Just make sure you’re not dreaming at the time!