Buying a home can be exciting and overwhelming at the same time. The house hunting can be fun. You get to look for a home that fits your needs and wants. The mortgage shopping might not be as fun. But it is the most important part.
Before you fall in love with a home, it helps to figure out what you can afford. A big part of this process is how much money you put down on the home. The down payment and the closing costs affect what you can purchase. You must be able to verify your source of funds. If you can’t, you may not be able to use the money as desired.
Why Lenders Care
First, you might wonder why lenders even care where your funds come from? It’s money, right? The problem is it could be borrowed money. Lenders also worry that the funds may belong to someone else. This could occur if you withdraw the funds from a joint account. If this is the case, you may need approval from the joint account holder. This only occurs if the joint account holder is not on the mortgage. This person must confirm that you have 100% access to the funds and that no repercussions will occur as a result of its use.
As a general rule, the money you use for a down payment or closing costs should be yours for at least 2 months. This means the money is in your checking or savings accounts for that amount of time. Again, it should be in an account solely for the people on the mortgage. However, there are a few other things you must verify. You can’t just obtain money from someone else and put it in your account for a few months. Lenders must still source the funds.
How Lenders Verify the Source of Funds
This is where things get tricky. Many borrowers think the underwriter is just being “picky” when they ask for the numerous docs, but they are just being careful. If the money is yours and not a gift from someone, you will likely provide your last 2 months’ of bank statements. The lender will go over them and see if there are any ‘large deposits.’ This means any deposits that don’t coincide with your regular income. What a lender considers large is rather subjective, though. A few hundred dollars probably won’t matter. But, a few thousand dollars would need an explanation and possibly proof.
If your funds are a gift, you must supply more proof. Lenders need proof of where the money came from and that it was given to you. This can be done with the following:
- Copy of the original written check
- Copy of the canceled (deposited) check
- Copy of the deposit ticket
The donor will also have to write a gift letter stating the money is a gift and no repayment is necessary.
Keep in mind, some loan programs, such as FHA, will require the donor to source the funds as well. They do this by requesting a copy of the donor’s latest bank statement. If there is a large deposit, its source might be questioned. The lender must make sure the funds are not borrowed funds.
A Real Life Example
Let’s look at a real example to put things into perspective.
You plan to purchase a $150,000 home. You are using conventional financing and putting down 10%. This means a down payment of $15,000. Your closing costs will equal $5,000. So you need $20,000 total. You have $10,000 and your parents are gifting the other $10,000. Your lender knows this and will proceed accordingly.
What you can’t do is accept the $10,000 and close on your loan. The lender must source the funds. It’s best if you wait until you have a loan in process to accept the money. This way the underwriter can tell you how to proceed. In many cases, you would do the following:
- The donor would provide you with a cashier’s check for the money
- You make a copy of the check and deposit it in your account
- You make a copy of the deposit ticket
- Once the check clears, the donor provides the lender with copies of the last 2 months’ bank statements
- You provide the lender with the copy of the check, deposit ticket, and the last 2 months’ bank statements
Every lender has different requirements regarding gift funds. Always talk to your lender first before accepting funds. If you have already accepted them, make sure you have a paper trail. Document every deposit with as much paperwork as you can. This helps the lender know the funds are not borrowed and are a valid gift.
Gift funds are widely accepted and a great way to buy a home. But, you must follow the rules carefully. How you verify the source of funds is crucial. One missed step and you could have issues with your down payment. The good news is many loan programs allow down payment assistance. Conventional loans allow gift funds for the entire down payment if you put down at least 20%. If the down payment is less than that, you have to contribute some of your own funds. For government-sponsored loans, such as FHA, the entire 3.5% down payment may be a gift. The exception to the rule, however, is if you have a credit score lower than 620. In this case, 3.5% of the funds must be yours. This means a donor can help you with the closing costs.
The bottom line is you must source your funds. We suggest talking to your lender before making any moves. This way you know you are doing it right. It is much harder to go back and undo what you did than to wait and see how to proceed. In the end, you could end up with some great help in the purchase of your new home.