Buying a home requires more than providing proof of your income and employment. Yes, you need have a good credit history too. However, the one main factor that could prevent you from securing a mortgage is improper proof of funds. This affects nearly every borrower unless you use a mortgage program with no down payment requirements and someone else, such as the lender or seller, pays your closing costs. Understanding how to prove your funds in a way that is acceptable to the lender is crucial to the success of your mortgage transaction.
The Types of Funds
There are three types of funds – down payment, money for closing fees, and cash reserves. Each type will differ based on the mortgage program you used and what you agreed upon in your sales contract. For example, if you apply for an FHA loan, you only have to put 3.5% of the sales price down on the home. If you qualify for a conforming loan, however, you might put down closer to 20% in order to avoid paying for Private Mortgage Insurance. The larger amount of money you need, the harder it is to prove the where the funds originated.
Money for closing costs will obviously differ from loan to loan and with different lenders. The amount you need will depend on the closing costs you must pay and those you negotiated with the lender or seller to pay. No matter how much money you need, the lender needs to verify where the money came from. This is their way of making sure you don’t have any other loans outstanding that would put their investment in you at risk.
Cash reserve requirements also vary based on the loan program and the lender’s requirements. Not every program requires you to have money on hand in an “emergency type fund.” If you have borderline qualifying factors, though, the lender may use your reserves as a compensating factor. For example, a borrower who has 6 months of a full mortgage payment on hand poses a lower risk to the lender than a borrower with no money on hand.
Typical Accepted Funds
No matter if you need to proof of funds for a down payment, closing costs, or cash reserves, you can only use accepted funds. These are funds most lenders consider acceptable because they are liquid and easily accessed.
- Money in a checking/savings account – This is the most common and easily proven type of funds. The money you receive from your job that you place in your bank account is easily traceable. Lenders can approve it because they know where it came from. However, if you have any large, unusual deposits in your account, the lender may ask for proof of where it came from. Again, they need to make sure you don’t have any outstanding loans whether from relatives or another bank. Every deposit must have some type of paper trail showing its origination.
- Stocks and Mutual Funds – You can typically use any type of investment you have as long as it can be sold quickly and turned into cash. Of course, just like anything else, you have to have a paper trail. The transaction history is the easiest way to prove the funds. When you sell the investment, get a receipt. Then when you deposit the money directly in your bank account, get another receipt. The dates and amounts need to coincide in order for the lender to accept them.
- Retirement Funds – Your retirement funds may or may not be eligible for use. It depends on the type you have and how vested you are in the account. If you have an IRA outside of your employer, you may be eligible to withdraw up to $10,000 for use without penalty. This pertains to you and your spouse separately, for a total of $20,000. If you have a 401K with your employer, you can take a loan, not a direct withdrawal. Luckily, this loan should not count against your debt ratio.
Knowing the types of accounts lenders can accept for proof of funds for a mortgage transaction is just the first step. You also have to know the acceptable documents allowed by most lenders. Again, you cannot just say you transferred money from here to here – you have to have a proper paper trail. Typically, any documentation must be on the bank’s letterhead, have the date, your name, and the amount of any transaction. Basically, any of the following documents usually suffice:
- Bank statement
- Financial statement from broker
- Statement of balance from money market or retirement account
- Letter from certified accountant
Any documentation you provide must have an official signature from a member of the financial institution in order to make it official.
The Timeline for Proof of Funds
Another issue you may come across when trying to come up with proof of funds in a mortgage transaction is the timeline of the funds. Most lenders require seasoning of the funds. This means you have had the funds for a specific period of time. This does not typically apply to money you make from your employment, but any other deposits it may apply. Generally, lenders want to see the funds in your bank account for at least 60 days in order for it to count, but every lender is different.
Coming up with proof of funds for your home purchase is important. Without it, the lender cannot approve your funds, which could leave you without a mortgage. Consider ahead of time every financial transaction you make. The lender will look at your bank statement very carefully to determine if you made any transactions that are not within the parameters of mortgage approval. You cannot just transfer funds from one account to another and expect the lender to use them. Instead, you have to have a proper paper trail and seasoning in order for you to get maximum use out of the funds you have available to purchase a home.