If you're considering purchasing a home soon, it is critical to understand the documentation requirements to which lenders are subjected in today’s lending environment. Hopefully, this information will save you a lot time and grief as it pertains to the documentation of your down payment monies (referred to as "assets" by your lender).
As a Senior Loan Processor, documenting assets often times is my biggest challenge in getting a loan fully approved.
Let’s discuss the rules first. As Fannie Mae is the largest backer of conventional financing, we’ll reference their underwriting guidelines. They state:
Fannie Mae Asset Guidelines
When bank statements (typically covering the most recent two months) are used, the lender must evaluate large deposits, which are defined as a single deposit that exceeds 50% of the total monthly qualifying income for the loan. Requirements for evaluating large deposits vary based on the transaction type…
The full guidelines are available here.
Why do Fannie Mae, FHA, VA, etc. even care about large deposits? The answer is simple. These institutions need to be absolutely certain that borrowers did not take out a loan to come up with their down payment monies. New loans can take months to show up on a credit report. Loans from friends, employers, etc. may never show up. New loans impact a borrower’s debt ratio, which is a critical piece of the loan qualification process.
To make more sense of this, let’s take a look at an example to see how this works.
Assume Mr. & Mrs. Smith are both employees earning W2 wages and have a combined $6,000 a month in income.
|$2,000 – Payroll|
|$1,000 – Payroll|
|$3,500 – Personal check|
|$2,000 – Payroll|
|$1,000 – Payroll|
None of the payroll checks above need documentation. However the $3,500 is more than 50% of the Smith’s monthly income (58.33%) and therefore needs to be documented.
If the personal check came from a family member, the terms for providing the monies to the Smiths will have to be documented. Is the $3,500 a loan or a gift? If it is a loan, what are the terms and how does this impact the Smith's debt ratio? If it is a gift, further documentation will be needed, such as the completion of a gift letter (a form letter lenders use).
If the $3,500 is not from a family member, then who provided the money, and why? Did an asset get sold? If so, documentation proving that would need to be provided.
What happens if it is a gift from a non-family member? Most often those monies cannot be considered, and the lender will reduce the assets of the Smiths by $3,500. This may put their loan approval in jeopardy.
As you can see, this process can get ugly fast. It is critical to note the lender will require two months of bank statements (all pages, even blank pages) and will review each and every deposit in those two months.
Here are some of my tips to prevent getting into documentation difficulty.
If you need to use some cash on hand for your down payment, put it in the bank at least 60 days prior to starting the loan application process.
Do NOT deposit cash or personal checks without speaking to your loan officer or loan processor first.
If you’re self-employed, do NOT transfer monies between your business and personal accounts. Why? You will trigger the requirement to show two months of business statements. Large deposits in those accounts will likely need to be documented as well.
Using gift funds from family members as a down payment? Be prepared that they will have to fill out paperwork and in some cases prove they had the money to provide you the gift as well (yuck!).
So the easiest way to avoid documentation work is to have your monies in the bank two months or more prior to beginning the home purchase process. If that’s not possible, then be sure to speak with your loan officer or processor and map out a strategy to document assets properly. It’s okay to use tax refunds, gifts, etc., however, you should know prior to depositing these funds whether you're making the process easier or more difficult on yourself.
Best of luck on your home purchase!