SANTA CRUZ (October 19, 2008) - It is no secret that many first time homebuyers get help from family members to cover at least part of the cash necessary for the down payment and closing costs. Even during the times that the mortgage industry allowed 100 percent financing, it was common for family members to kick in some cash in order to help the homebuyers obtain a lower mortgage and, consequently, a lower monthly payment.

There are actually two ways that family members can help out. They can either become a co-signer and, thus, a co-borrower or they can contribute cash. The reality of becoming a co-signer dictates that they must not only provide their tax returns and bank statements but their credit history now becomes at risk because if the occupant borrower makes a late payment on the mortgage, the family member’s credit report will likewise suffer a damaging black mark! Today, the only loan program that allows co-signers is the FHA loan program.

Parents who have the ability to contribute cash are much more likely to help in that way rather than to become a co-signer with their son or daughter. Some parents are reluctant to give their kids more than $24,000 ($12,000 from each parent) because they had heard that there are tax consequences. Actually, as I understand it, regardless of the amount donated, income taxes will not go up for either the parents or the kids as a result; however, a gift tax return will have to be filed by the donor. I strongly suggest that interested parties contact their accountant to confirm the details.

Rules vary regarding the maximum size of a gift. FHA allows all of the down payment to be a gift. Conventional loans require that if the gift is less than 20 percent of the sales price, the homebuyer must contribute at least 5 percent of the sales price from his or her own funds. The definition of ‘own funds’ is money that has been in the homebuyers’ bank accounts for at least two monthly bank statements.

There is specific paperwork that must accompany a gift or it will not be allowed. There must be a gift letter that states something like this: ‘I am donating $50,000 to my son, Jim Ofstad, to help him buy the home at 108 Hellroaring Rd and I do not expect repayment.’ The letter needs to be complete with donor’s name, address and phone number.

Additionally, the homebuyer must document the source of the gift and the deposit of the gift into one of his accounts or directly into the escrow account. The best way to document the source is to have the donor obtain a cashier’s check that clearly states whose account the funds came from. The check can be made out to either the homebuyer or the title company. In any case, the homebuyer must furnish a copy of the cashier’s check and a copy of the deposit slip (into either the homebuyer’s existing bank account or into the escrow account).

Enforcing these guidelines is a tough job. More than once, my clients have let me know that they feel like an escaped felon when I tell them we cannot close the transaction until all of the requested paperwork is in. Now, more than ever, lenders are scrutinizing the borrower’s documentation for accuracy and compliance. They do not hesitate to say ‘no’ if the paperwork is not complete.

This column is written every Sunday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 of email him at Peter@SantaCruzHomeFinance.com.