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Do’s and Don’ts of Down Payments

how to buy a house with no money down

More than half of renters think they need a bigger down payment to get a mortgage than lenders actually require, according to a  2017 Urban Institute report. The truth is, there are plenty of options that require down payments of 3.5% or even lower, so you may be closer than you think to have the cash you need to purchase a home.

But no matter how small a down payment you plan to make, it’s important to know the rules for how to manage and document the money you’ll put down. Since the housing meltdown of 2008, new laws have gone into effect that require lenders know the details about the source of your down payment funds. You’ll want to follow them closely to avoid delays in getting your home loan approved.

The do’s of down payments

Know how much you need first

Most homebuyers will choose a conventional, FHA, VA or USDA loan to finance the purchase of a home. Each has their own down payment requirement that you’ll want to know before you start applying.

Below is a brief overview of the minimum down payment you’ll need and the eligibility requirements for each.

  • Conventional loans: Conventional loans are not insured or guaranteed by the government, and follow guidelines set by secondary market buyers Fannie Mae and Freddie Mac. Generally, conventional loans require a minimum down payment of 3%. Some conventional loan programs may have limits on the amount of money you make, so be sure to check with your loan officer if you are planning to apply for a 3% down payment conventional loan.
  • FHA loans: An FHA loan is a government-backed mortgage loan insured by the Federal Housing Administration. The minimum down payment requirement is 3.5%, and there are limits on how large a loan you can take on based on the county your new home is located.
  • VA loans: Veterans of the military or people still on active duty may be eligible for Veterans Administration loan programs. The VA loan program allows for mortgages without any down payment, within limits on the cost of the home being purchased.
  • USDA loans: For buyers interested in purchasing a house in rural areas of the United States, a USDA loan offers a loan program with no down payment required. Income limits apply, and the property must be in an area that is eligible for USDA financing.

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Know how to document the money you’ll need for the down payment

When you’re making a down payment, you’ll need to have some sort of documentation for where the money came from. There is a right way to do this, and then there’s a wrong way to do it that will cause stress, delays and could even result in a loan denial. Why such scrutiny on down payment money? Mortgage fraud and money laundering.

Mortgage fraud cost the mortgage industry a huge percentage of the $500 billion in losses experienced from foreclosures between 2007 and 2012. Many communities still haven’t recovered from the damages of plummeting prices and defaulted loans. Some mortgage fraud schemes involved cash for down payments that were undocumented. Later investigations revealed the cash was from parties that were paying people to buy homes that they would never live in.

At the same time, money laundering was a big enough problem in the mortgage industry that new laws were passed that require more analysis of how often deposits are made and where they come from. Lenders have to know the source of banking deposits to make sure criminals with fake businesses aren’t using real estate purchases to hide illegal funds.

Here are the most common ways people get the money for down payments, and how to document the money correctly.

The most common sources of down payments

Mortgage lending guidelines actually allow for many different sources for down payment. The down payment options below are the ones most commonly accepted by all mortgage lenders.

Your loan approval process will be much more pleasant if you follow the paperwork requirements for documenting different types of down payments.

  • Checking and savings balances last 60 days: Lenders are going to look at the most recent 60 days of banking activity on your bank statements. You’ll need to provide all the pages of the statements. The deposits in your bank accounts should be easy to document (direct deposits from your paychecks are an example), and there should be enough money in the account to meet your down payment requirement.
  • Retirement liquidations or 401(k) loans: You may be able to money funds in a retirement account without a tax consequence to buy a house, or take out a 401(k) loan. In either case, you’ll need two months of balance statements and your liquidation paperwork.
  • Gifts:  FHA and conventional loan programs allow you to get your entire down payment as a gift. There are strict documentation requirements not only related to the gift money itself but for the establishing your relationship with the person gifting you the money. You’ll need to show how you’re related to the donor, where they got the money and that the money won’t need to be repaid.
  • Sale of an asset, like a car: You can sell any asset for a down payment to buy a house, but meeting the documentation requirements may be difficult. Whether it’s a car, or a vintage baseball card collection, you’ll need to document that you own the vehicle and provide a bill of sale.

Less common sources of down payment

The following down payment sources are allowed but not as common — and some lenders may not allow them to be used at all. If you are considering a down payment from any of these sources, make sure you let your loan officer know.

  • Cash on hand: Otherwise known as “mattress money,” this refers to funds that you haven’t deposited into a bank for the last 60 days. You’ll need to deposit the cash into a regular bank or credit union to get approved, and document how you saved the money by preparing a budget that verifies your income, spending habits and history of banking relationships.
  • Loan against an asset (like a car): You can generally borrow money against an asset like a car and use it toward a down payment. The reason most people don’t do this is fairly obvious — you are creating an additional monthly payment obligation. Your debt-to-income ratio will need to take into account the new asset loan payment and your new house payment.
  • Home equity line of credit: If you own another property secured by a home equity line of credit, you can use the line of credit to purchase another home. You are increasing your debt load with the new payment on the amount you charge and the mortgage payment of the house you are buying, so it’s an expensive down payment option.
  • Sweat equity: If you have handyman skills and don’t mind buying a property that needs some fixing up, you may be able to convert your labor into a down payment source. The process is complicated  — you can learn more about the nuts and bolts of sweat equity as a down payment here.

The don’ts of down payments

The best way to avoid problems with down payment documentation is to wait on purchasing a home until you’ve got your down payment saved up and sitting in your bank account for at least 60 days. Your lender may be able to find a solution if you’ve already made one of these mistakes, but it could create a lot of delays, and in some cases, could result in a loan denial.

Don’ts with your down payment documentation

Don’t deposit large amounts of cash that can’t be documented back to some source: If there are any deposits in your account over 1% of your sales price for an FHA loan, or more than 50% of your pretax income for a conventional loan, the lender may not allow you to use the money toward your down payment requirement unless you can adequately explain where the money came from and document it.

  • Don’t charge up a credit card for down payment funds: Lenders don’t allow you to borrow unsecured money for a down payment.
  • Don’t take out an unsecured installment loan, like a personal loan, for a down payment: Unsecured debt is a definite don’t — whether it’s a personal loan or a credit card.
  • Don’t discard your bank statements or deposit receipts: If you are in the habit of throwing out your most current bank statements, you’ll want to break the habit, so you have the documents needed for the lender to approve your assets.
  • Don’t ask for gifts from multiple sources: You may have a big family with multiple members that want to give you a portion of the total down payment you need, but you’ll need to have a gift paper trail for each and every one of them.
  • Don’t forget to tell your loan officer if you’ve already done any of the don’ts above: If you let your loan officer know about any of the above before you apply for a loan, or as early in the loan process as possible, chances are there will be a viable solution.

Final down payment thoughts

The key to a good down payment experience is to know how much you need for the amount of home you are buying, and have it in your bank account two to three months before you apply for a mortgage.

If you’re getting your money from a gift or by liquidating of any type of retirement account, be sure to give yourself plenty of lead time to get all of the documentation together so you aren’t scrambling at the last minute. It may even be a good idea to wait to apply for a mortgage until you’ve got all of your down payment paperwork finalized


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