That’s a question I get asked by wide eyed, bewildered clients when their loan officer tells them they have to prove where their down payment money is coming from. They ask, “Why does it matter? Why should they care?” Well, let me see if I can shed some light on the situation…
First of all, the minimum amount of cash down payment required varies with your loan type. VA and RD loans do not require any down payment from the buyer. FHA requires a minimum of 3.5% of the purchase price (ie. $3500 on a 100k property), and Conventional loans require 5%. There are a couple exceptions to those rules, but they don’t factor in very often. And keep in mind that closing costs typically run around $4-5000; and someone has to pay those- either the buyer or seller. They are a negotiable item.
On VA, RD and FHA loans, the buyer can use their own money or they can receive a gift from a relative, employer or (in some cases) a close family friend. To use the gift money, the person giving the gift must sign a form called a “Gift Letter” where they affirm that the money is their’s and being given as a gift (ie. no repayment is intended). They also must supply a bank or investment account statement evidencing that the money is their’s. For any other funds the buyer is using to pay down payment or closing costs, they’ll have to prove where the money came from (unless it was in the bank or an investment account for the past 60 days).
On Conventional loans, anything above the minimum 5% required cash down payment may be gift funds. And like on the other loan types, the source of the funds will have to be verified unless it was in the bank or an investment account for the past 60 days. (Read that last sentence again- carefully. It can be a deal breaker.)
On Contract deals, the source of funds does not usually have to be proven.
So, why does it matter? Basically, there are two reasons why the lender wants to know where the money is coming from. First, it a general rule of lending is that borrowers who have some “skin in the game” have lower default rates than those who do not. Makes sense. I mean, if you’ve put some siignificant amount of your own cash into the deal, you’re less likely to give up and walk away from your investment. Secondly, the lender wants to know if you’ve borrowed money to come up with the down payment or closing costs. This makes sense as well. If you’ve borrowed money, then the amount that will need to be repaid each month should be taken into consideration when evaluating your debt-to-income ratio to see if you qualify for the loan.
There are a lot of things in the mortgage business that don’t make sense. These requirements, however, do help the whole system to function better— and in the end, that is good for home owners.
If you have questions about your own situation, please call. I’ll be happy to help you find your way through the mortgage maize!