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Borrowed Funds an Unacceptable Source of Down Payment Dollars - 2007-12-08 |
In the wake of the current mortgage crunch, lenders still have plenty of money available for qualified borrowers. But loan underwriters, the folks who actually stamp your loan application as approved or denied, have tightened up the guidelines for borrowers at all levels.
As we saw last week, one way to make your loan application more attractive to lenders is to increase the amount of your cash down payment. Not only does this have the effect of speeding your loan approval, but a larger down payment may also win you a lower interest rate or even slightly better terms.
A down payment is an initial, partial payment toward your home purchase, and it represents that portion of the price you intend to pay yourself. In general, the larger your down payment, the less likely you will be to default on the loan, at least in the eyes of the lender.
Lenders draw a direct inverse relationship between risk and down payment size.
For example, if you intend to make a small down payment, say 5 percent or less, your application will draw greater scrutiny, and additional costs and private mortgage insurance may be required.
With a down payment of 20 percent, most lenders will offer you their best rate and feel comfortable that you have a substantial investment in your purchase. Statistically, very few loans made at 80% or less of a home's value go into default, and even if they do, the lender can usually recover most of their investment.
So, if you are shooting for a 20% down payment in order to get the best rate and the lowest costs, what funds are unacceptable as a source for your down payment?
* Borrowed funds are always suspect. You can't just go to the bank and get a cash advance on your credit card, then hope to use that as a down payment. From the lender's standpoint, your cash advance must be paid back in monthly installments, and that additional obligation could jeopardize your ability to repay the home loan.
From the bank's perspective, you are asking them to grant you their best terms in exchange for lowering their risk. But if you have borrowed the funds from another source, you now have another financial obligation, thus putting their loan at higher risk.
Another problem may arise when you try to use funds that you have borrowed against the equity you already own in another property. Depending on the lender's underwriting guidelines, this form of "secured" funds might be acceptable, provided you disclosed your intentions on your application and the underwriter felt you could handle the projected monthly debt load.
* Unexplained cash on hand is generally not acceptable as a source of down payment funds. You can't just show up at closing with a briefcase full of fifty dollar bills. You must be able to explain to the lender where the money came from. For example, if you sold a car for cash, you should have a bill of sale; if you sold a rental house, you should have a closing statement.
Furthermore, even if you have a reasonably good explanation for the fact that you have all this cash, the lender will not allow it as a source unless it is "seasoned" for at least 60 days in a financial institution. That means you must put the money into a regular account at a bank or credit union and leave it there for at least 60 days. Only then are those dollars considered "seasoned" funds, and can be used for a down payment.
* Sweat Equity is another problem area for down payment dollars. Investors and home buyers often think that if they offer to perform work and labor to improve or increase the value of a property, that the lender will recognize the enhanced value of the property as the basis for determining a down payment. Unfortunately, it is almost impossible for a lender to establish the value of promised improvements, especially before the work has even begun. Therefore, sweat equity will not work as a down payment.
* Personal Loans disguised as gifts, especially from friends or family members, will be scrutinized carefully if you try to use them as down payment dollars. Depending on the type of loan you seek, a gift may be used for some or even all of the down payment, but there are conditions the lender will likely attach.
First, the borrower must disclose the gift as a source of funds before the closing, so that the underwriter can take this factor into consideration. Next, the gift must be made with no expectation of repayment, and the giver must typically sign a "gift letter" explaining the generosity. Finally, if the lender approves this arrangement, the requirement for seasoning still applies, and the funds must appear in the applicant's bank account for at least 60 days.
Remember that different lenders offer a variety of programs and may be able to accept down payments from many sources, so check with your loan officer for specific guidance in your search for a loan.
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