Gifted Equity Explained: How It Replaces Your Down Payment

Gifted equity is a way for a family member to help you buy a home without handing you a cheque. It's a replacement for a down payment in cold hard cash. It also gets misunderstood a lot, so let's go through it step by step.

First, how a normal purchase works

Let's say you're buying a home for $600,000 and putting 20% down. (You can put down less than 20%. I use 20% here because the numbers are easy to follow.)

Your down payment, from your own savings: $120,000
Your mortgage, the loan from the lender: $480,000
Together, that's $600,000, which is the price of the home.

The seller gets all $600,000. $120,000 is your cash and $480,000 comes from the lender.

What is equity?

Equity is the part of a home that you own, as opposed to the part you owe the lender for. The simple way to work it out is:

What the home is worth, minus what's owed on it = your equity.

If a home is worth $600,000 and you owe $480,000 on the mortgage, you own $120,000 of it. That $120,000 is your equity.

How a normal purchase works

Let's say you're buying a home for $600,000 and putting 20% down. (You can put down less than 20%. I use 20% here because the numbers are easy to follow.)

Your down payment, from your own savings: $120,000
Your mortgage, the loan from the lender: $480,000
Together, that's $600,000, which is the price of the home.

The seller gets all $600,000. $120,000 is your cash and $480,000 comes from the lender.

On day one, the home is worth $600,000 and you owe $480,000, so you own $120,000 of it. Your down payment became your equity.

How gifted equity works

Now say your parent is selling you their home, which is worth $600,000. Instead of asking you for $120,000 in cash, they say, "Consider that $120,000 a gift."

The price of the home is still $600,000.
Your down payment is $120,000, but it's covered by your parent's gift of equity. You don't pay any cash for it.
Your mortgage is $480,000.
Your parent receives $480,000, which is only the amount the mortgage covers.

The $120,000 doesn't go anywhere. It stays in the home as your equity from day one. The home is worth $600,000, you owe $480,000, and you own $120,000 of it.

The end result is the same as the normal purchase, with one difference. In the normal purchase the $120,000 came from your savings. Here it came from your parent's equity.

Does it have to be 20%?

No. Gifted equity can be less than 20% of the price, the same as a cash down payment can. With less than 20% down, your mortgage usually needs mortgage default insurance, and the premium is added to your mortgage. How much equity you gift is up to you and your family. We'll work out the right amount for your situation.

The two things people get wrong

"So I can get a 100% mortgage." No. Gifted equity replaces your down payment. It doesn't remove the need for one. The lender still sees a $120,000 down payment, so the mortgage is $480,000, not $600,000. A lender won't lend you the full price of the home, even from family.

"The person gifting the equity gets the money." No. Your parent never receives the $120,000. It stays in the home as your equity. Your parent receives $480,000, which is only the amount the mortgage covers.

What you still pay for

Gifted equity covers your down payment. You'll still need your own money for closing costs, like legal fees and property transfer tax, plus any other costs of buying.

What the lender will want to see

Every lender is a little different, but expect to provide:

A gift letter confirming the equity is a gift and not a loan that has to be paid back.
An appraisal, so the lender can confirm the home is actually worth what the price says.
Proof of who the family member is, since lenders usually only accept gifts from close family.

Talk to someone before you agree

If you're thinking about this, call me before anything is signed. Selling a home to family below its value can have tax consequences for the seller, so check with an accountant as well. Reach out and we'll look at whether gifted equity works for your situation, and I'll tell you what your lender will need. You can also read about gifted down payments when the gift is in cash.