Can the FHA Down Payment Be Borrowed, in the Form of a Temporary Loan?

Reader question: “My wife and I are planning to buy a house with an FHA loan later in 2014. We both make good money and have decent credit scores in the mid to high 700s. We should be able to come up with the 3.5% down payment required for this program, but it will basically wipe out our savings. I’m hoping to borrow some funds to cover this upfront expense, or at least part of it. Is this allowed? Can the FHA down payment be borrowed in the form of a temporary loan?”

That depends on what you mean by the word “borrowed.” If you’re planning to get the money from a friend or family member who expects you to repay it (i.e., a loan), then technically it’s not allowed.

FHA does not allow borrowers to use such loans for their down payment funds. But they do allow the money to come in the form of a gift, as long as no repayment is expected. Certain types of collateralized loans are acceptable as well.

Borrowing from Family Not Allowed, But Gifts Are Okay

The Department of Housing and Urban Development (HUD) is the federal agency that manages the FHA loan program. They also establish the rules for down payments, acceptable sources of funds, and all other aspects of the program.

Current 2014 guidelines require borrowers to put at least 3.5% down, when using an FHA loan to buy a house. According to HUD Handbook 4155.1, Chapter 5, Section B:

“Under most FHA programs, the borrower is required to make a minimum downpayment into the transaction of at least 3.5% of the lesser of the appraised value of the property or the sales price.”

For example, a borrower buying a home for $300,000 would have to make an investment of at least $10,500 (300,000 x .035 = 10,500).

The handbook mentioned above also includes a list of “acceptable sources” for down payment funds. Unfortunately, borrowing the money from a family member is not on the list. You cannot use a loan from a friend or family to cover your FHA down payment — at least not if repayment is expected. But you can use a gift from such an individual.

What is considered a gift? HUD guidelines state the following: “In order for funds to be considered a gift, there must be no expected or implied repayment of the funds to the donor by the borrower.” You’ll need to obtain a gift letter from the donor that states as much.

Recap: The FHA down payment cannot be borrowed in the form of a loan from family or friends. But you can have the money donated or “gifted” to you, as long as no payback is required.

Read: Update on down-payment assistance rules

Using Collateralized Loans for FHA Down Payment

In certain scenarios, collateralized loans and housing-assistance grants can be used to fund the borrower’s down payment. A collateralized loan is secured by some form of collateral, such as real estate property or financial investments. HUD has specific rules about using these types of loans for down payment and closing costs on FHA loans. For one thing, you must show that the loan is secured by some kind of collateral.

Here is what HUD says about using collateralized loans for down payment and/or closing cost funds:

“The borrower may obtain a loan for the total required investment, as long as satisfactory evidence is provided that the loan is fully secured by assets such as investment accounts or real property. These assets may include stocks, bonds, and real estate other than the property being purchased.”

Additionally, the following types of financing may be used for FHA down payments:

  • The money can come in the form of a grant from the Federal Home Loan Bank’s (FHLB) Affordable Housing Program.
  • Down payment funds can also come from grants or loans provided by state or federal agencies. An example would be a disaster-related housing grant from the Federal Emergency Management Agency (FEMA).
  • Disaster relief loans administered by the Small Business Association (SBA) can also be used for FHA borrower funds.

These are not the only ways to borrow an FHA down payment with a collateralized loan. To learn more about your funding options, refer to Chapter 5 of HUD Handbook 4155.1, or speak to a HUD-approved housing counselor.