Earlier this year, we published a guide to FHA loan down payments.
Since then, we’ve received quite a few questions from borrowers on that subject.
A common question among home buyers who are considering this program is: Can I borrow my FHA down payment from someone else?
The short answer is no. The funds used for the down payment on a Federal Housing Administration-insured mortgage loan cannot be borrowed. But they can be gifted. That’s a key distinction.
The difference between borrowing the money and having it gifted to you comes down to one thing: the expectation of repayment. In fact, those very words are used within the official HUD handbook that covers the FHA loan program. (We’ll look at the applicable portions of the handbook in a moment.)
You Cannot Borrow FHA Down Payment Funds, But…
Before we go any further, let’s define what the word “borrow” means in this context. When you borrow money in the classic sense, there’s an understanding that you will have to repay the funds at a later date.
The repayment requirements might be put down in paper, as is the case with a personal loan from a bank. Or it might be a verbal agreement, like when you borrow money from a friend. But the key point here is that in a borrowing scenario, you are expected to repay the money at some point.
And that is generally not allowed when it comes to FHA down payments.
The distinction between borrowing money for your FHA down payment and have it gifted to you is spelled out in the Single Family Housing Policy Handbook. Also known as HUD Handbook 4000.1, this is the official policy guide for the FHA mortgage insurance program.
In part II section ‘A’ of that handbook, we learn about down payment gifts. This is when a third party gives the borrower money to help cover some or all of their required upfront investment.
As it states: “Gifts refer to the contributions of cash or equity with no expectation of repayment.”
Notice the “repayment” language being used here. If you borrow money to put toward the down payment on an FHA loan, there would likely be an expectation of repayment. You would have to pay the money back at some point. You’re basically using one loan to cover the down payment on another, and that’s generally prohibited under FHA guidelines.
To be clear: It’s usually acceptable to receive money from an approved third-party, to put toward your down payment and/or closing costs. As long as the person providing the funds does not expect repayment, that’s generally permissible.
Elsewhere in the handbook, it mentions the documentation requirements for these types of scenarios. It says that the mortgage lender “must obtain a gift letter signed and dated by the donor and Borrower that includes … a statement that no repayment is required.”
What About Conventional Loans?
So we’ve answered the primary question at hand: Can the FHA down payment be borrowed?
If the person providing the funds expects you to pay it back, then the answer would be no. That’s considered a loan. But if the donor is giving you the funds as a gift — with no expectation of repayment — then it would be acceptable under FHA guidelines.
Conventional mortgage loans typically have similar requirements, when it comes to borrowing money for the down payment. In most cases, that kind of things is prohibited.
Did you know? A conventional or “regular” mortgage loan is one that is not insured or guaranteed by the government. That distinguishes it from the FHA program, which does receive government backing.
These days, most conventional home loan programs allow borrowers to receive gift money from a third party. These gifted funds can be applied to the down payment and, in some cases, the closing costs as well.
But lenders usually don’t allow borrowed funds to be used for the down payment on a conventional loan.
Reducing the Risk of Default
When you consider the reason for the down payment on a home purchase, it’s easier to understand why you can’t borrow those funds from someone else (in most cases). So what’s the purpose?
According to the Department of Housing and Urban Development (HUD), which oversees FHA loan program: “The cash downpayment serves the important function of mitigating mortgage credit risk.”
In this context, the “risk” refers to those scenarios where borrowers can no longer keep up with their mortgage payments and fall into foreclosure. So we’re talking about risk to the lender, primarily.
Statistics show that the risk of borrower default (or failure to repay) typically increases with a smaller down payment, and decreases when borrowers put more money down. Borrowers who do not make any kind of upfront investment — and therefore have no “skin in the game” — represent the highest risk of default.
Additionally, when a home buyer using an FHA loan borrows down-payment funds from someone else, they are increasing their debt burden on two fronts. They’ll have to repay the mortgage loan itself, as well as the money loaned to them for the down payment. This can lead to an even higher risk of borrower default. And for that reason it’s generally prohibited.