Get Your Savings Ready to Buy a Home
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First things first: You do not need to save 20% for a down payment to purchase a home. According to a 2018 study by the Urban Institute, 39% of the renters surveyed believed they needed to put down 20% or more to buy a house. Many of them stayed on the homebuying sidelines, not knowing that there are many purchase programs with down payment options of 5% or less.
Besides down payment, savings plays a critical role in various aspects of a mortgage pre-approval and homeownership in general. You’ll need money for closing costs, potential repairs to the property and, in some cases, you may need to show extra funds in your account to show you’ve got a couple of months of mortgage payments saved.
It’s also important to know how to document your savings. There are different requirements for where the money comes from for mortgage loans, and documenting something incorrectly can create last-minute stress and delays if you haven’t followed the standard guidelines for showing a lender where your money is and how it got there.
Why savings are important when you’re buying a home
- The more you save to put down, the lower your monthly mortgage insurance payment will be. This is especially true if you put down less than 20%. In that case, lenders require extra insurance, and the calculation for your monthly insurance premium is directly tied to your mortgage loan amount.
- Your loan approval may be easier if you have more saved. Lenders like to see that you have savings. If you can make more than the minimum down payment, and have extra money on hand after your closing, studies have shown you are less likely to run into problems repaying your loan.
- Having extra savings shows you’ve got “rainy day” mortgage payment potential. Having a couple of months’ worth of mortgage payments in the bank after your closing makes a lender feel better about your ability to repay your mortgage. These rainy day payments are known as “reserves” in the lending world and may make the difference between an approval and a denial in certain cases.
- Reserves for potential repairs. While this isn’t a requirement for lending, it’s a good idea to have extra money set aside for repairs. Having extra savings for repairs can keep you from charging the repairs on a credit card.
Down payment requirements for different loan programs
The first thing you need to know to get your savings ready to buy a home is how much money you’ll need for the down payment. That varies based on the loan program you use.
- VA loans: If you are on active duty or a military veteran, you may be eligible to purchase a home with no down payment.
- USDA: The USDA loan program allows you to purchase a home with no down payment in rural areas of the country. To determine if a property you are interested in is eligible for USDA financing, click here.
- Down payment assistance: There are a variety of down payment public assistance programs that your city or state may offer. They may help you with some or all of the down payment requirement for your home purchase. Most of them have income limits and may also require you to buy in specific areas of the city or state.
- Fannie HomeReady/Freddie HomePossible: These conventional loan programs allow you to buy a home with as little as a 3% down payment. Like the down payment assistance programs, there may be restrictions on your income and where you can buy.
- FHA loans: The FHA program has a minimum down payment of 3.5% and gives more opportunities for first-time homebuyers to purchase than any other loan program. You can buy a house with lower credit scores and higher debt-to-income ratios than conventional loan programs allow. There are no income limits, but the maximum loan amount varies by county, so be sure to find out the limit for your area before you apply.
How much to save for closing costs and mortgage payment reserves
Once you have an idea of which program you are eligible for and the corresponding down payment, you’ll need to make sure you’ve got enough saved for the closing costs. Your real estate agent may negotiate to have the seller pay some or all of your closing costs, but that usually means you’ll pay a higher sales price.
On average, the closing costs will be around 2% to 5% of the price of the home you are buying. For example, on a $250,000 house, you’ll need to budget up to an extra $12,500 to cover the closing costs.
There is no specific lender rule for how many mortgage payments you should keep in the bank, although three to six months will give you a pretty good cushion. Automated underwriting systems may request a reserve of at least one mortgage payment if your credit scores are on the low side or your total debt is high compared to the income you have to qualify for the loan.
If you are buying a two- to four-unit property or an investment property, there may be specific reserve requirements, so be sure to discuss this with your loan officer if you plan to purchase this type of property.
No-nos for savings during the loan process
Avoid large cash deposits for your savings
If you Google “undocumented large cash deposits mortgages” you get 8,920,000 results. It’s a common mistake that creates big problems once you’re already in the process of getting your loan approval.
Maybe you received a cash gift of a several thousand dollars from a well-meaning grandmother, or your family has always felt more comfortable keeping cash in a safe at home than in an institutional bank.
The problem with big cash deposits is they may trigger red flags for money laundering. After the housing crash in 2008, investigators discovered that many of the homes that ended up in foreclosure were purchased as part of money-laundering schemes. One of the most common characteristics of these criminal activities was large deposits of cash in short periods of time.
The mortgage losses from these operations were so big that lawmakers passed legislation requiring lenders scrutinize deposits more closely and file suspicious activity reports with the federal government.
What does this have to do with your application for your dream home? In general, it means you should keep any money you plan to contribute for a future home purchase in a regular bank or credit union. Because lenders are going to require the most recent 60 days worth of bank statements, having your cash in an account for 60 to 90 days will make your life much easier when it comes time to apply for your loan.
Some cash deposit amounts may be acceptable
There are certain dollar amounts of cash deposits mortgage lenders consider acceptable. However, some lenders may still require documentation or an explanation, and some may not allow the cash to be counted toward your down payment at all.
- 1% sales price FHA rule: FHA guidelines allow for undocumented cash deposits equal to 2% of the sales price of the house you are buying, but most mortgage lenders will only allow 1% of your sales price for an undocumented cash deposit.
- 50% gross income Fannie Mae rule: Cash deposits that are 50% or less than your total gross income are allowed on conventional loans. You will probably still need to write a letter of explanation, but in general this is considered an acceptable deposit for a conventional loan.
Avoid using cash on hand
Similar to cash deposits above, unless you can document your assets with a bank statement, cash will open up a lot of extra documentation requirements, and some lenders won’t accept it at all. If you are adamant about not having your funds in a bank account, be sure to ask the loan officer you are working with if his company will accept cash on hand.
Don’t charge a credit card or get an unsecured loan
Unsecured debt can’t be used for a down payment, ever. Cash advances on your credit cards, personal lines of credit and overdraft accounts will not be allowed.
Acceptable types of savings and the documents you’ll need
In the mortgage world, the last two months of activity will be looked at the closest when it comes to your savings. “Seasoning” may be a term you hear your loan officer or loan processor use once you begin the loan process, and it refers to how long your money has been in the bank.
The most recent two months of checking, savings and money market accounts: Lenders will want to make sure the deposits in your checking, savings or money market accounts are from valid sources (e.g. employer direct deposits of your paycheck), and also check to see if you any non-sufficient funds charges (bounced checks or places where you spent more than you had in the account). If you transfer money between accounts, be prepared to provide bank statements from all the accounts that money is moving between.
Most current quarterly or two months of retirement, 401(k) or other asset verification: If your retirement accounts are issued quarterly, you’ll want to provide the most current statement. Some employer 401(k) and retirement accounts may have limits on when you are allowed to access them, so be sure to check if you plan to use these funds for your home purchase.
Assets you can liquidate or sell: The general rule for assets that you plan to sell or liquidate can seem complicated. You have to prove you own or owned the asset that you are liquidating or selling, and keep all the documentation showing the money you received going into your account.
Car paper trail: You’ll need the following if you plan to sell a car and use it toward the savings for your home purchase:
- Copy of title showing the car in your name
- Copy of the bill of sale between you and seller
- Copy of check from seller
- Copy of signed transfer of title
- Copy of the bank statement or bank transaction statement showing the funds into your account
Retirement account liquidation: Be sure you understand the tax consequences of any IRA liquidations, although there may be exceptions to the tax penalties when using the proceeds to buy a home. Here is the paper trail you’ll need:
- Copy of the retirement statement before the withdrawal
- Copy of all of the liquidation paperwork
- Copy of the retirement proceeds check or a bank statement showing the direct deposit into your account
- Copy of bank statement or bank transaction statement showing the retirement funds being deposited and clearing your account.
401(k) loan: You’ll need most of the same documentation as an IRA liquidation, as well as something showing what the payment will be on the 401(k) loan.
Gift funds for your home loan savings: Anyone providing you gift money will be required to provide some of their own financial documentation, so be sure to have this list handy when you talk to them about gifting you any money toward the savings you’ll need for your home purchase.
- Copy of a gift letter that indicates the money is coming from a gift, states no repayment is expected and shows information about what asset account the donor is providing the funds from
- A copy of donor’s most recent bank statement showing enough funds in the account to make the down payment, with no large deposits
- A copy of the gift check from the donor
- A copy of banking information showing the funds going into and clearing your account
- A copy of the donor’s bank transaction statement showing the funds clearing their account
Joint account access of your asset accounts: If you just graduated from college, have elderly parents or are newly divorced, you may have bank statements that show a parent, a child or ex-spouse on them as an additional owner of the account. You will want to have them taken off, or you’ll need a letter from them confirming you have 100% access to the account.
The key is to know and show what savings you’ll need to buy a home
If you understand how much you savings you’ll need, and decide how much of a savings cushion you want for the unexpected, your savings will be ready for you to begin the loan application process to buy a house.
Knowing the savings and asset documentation requirements, as well as avoiding the no-nos will make your buying experience much smoother, and help you avoid any potential delays in the mortgage approval process.