What do lenders want to see – day 1: Downpayment… Where is yours coming from?
A HUGE part of what we do as mortgage professionals is simplify the home-buying and home refinancing process for all of our clients. During every interaction, we do our best to educate and inform homebuyers and homeowners of the ins and outs of the homebuying process. As a team of 31 Mortgage Specialists, we send in literally dozens of mortgage applications for Canadians on a weekly basis and therefore have an intimate understanding of what the diverse needs of our Canadian mortgage borrowers are, what products exist in the Canadian Mortgage marketplace, and most importantly, in marrying the previous two together, knowing how to structure things properly to give lenders what they want to see as applications come across their desks. With this in mind, we have dissected a mortgage application from the point of view of the lender into four parts. Over the next four days, we will walk through an outline of the most important items that we recommend that mortgage-seekers should take note of to help ensure a smooth mortgage-seeking experience.
Essentially, there are ‘four corners’ to every mortgage application that we process:
- Downpayment
- Income/Employment
- Credit
- The Subject Property
Today, we’re going to investigate the ins and outs of that lenders look for in a mortgage application with relation to Downpayment.
Simply enough, the funds that you use as a downpayment serve as your equity into the transaction; it is your personal investment into a property when purchasing or refinancing. Lenders perceive this to be your ‘skin in the game’ and your commitment to follow through with the purchase and maintenance of the property: in a picture-perfect world, because you’ve invested “X” money, you are less likely to default on the payments and let the property go into foreclosure. Because of this risk-assessment analysis, The 0%-down mortgages of 2008 and earlier have disappeared. There are a few cash-back options that allow for downpayments lower than 5%, but it is important to note that these programs don’t make a heck of a lot of financial sense for most people considering that they’re based off of the higher posted rates and they have sizeable CMHC fees which make them less attratcive.
If you’re a new home buyer that does have at least 5% of the your home’s purchase price, there are several ways that you can source your downpayment for your new home purchase:
1) Your own resources: savings that you have accumulated through your own means, such as Savings, Mutual Funds, and Stocks. In the case of RRSP investments, you can withdraw your RRSP savings tax-free through the Government of Canada’s Home-Buyer’s Plan (HBP). If you are making periodical deposits to your RRSP investment accounts, please note that the money has to be “in” the plan for at least 90 days to be eligible for the HBP withdrawal program.
2) Family resources: a gift from an arm’s length family member (parent, sibling, spouse). Lenders will want to see a gift letter to prove the gift’s origin and will follow up two-fold: by calling the gifting relative to confirm the letter and by asking to see the funds deposited to the recipient’s bank account.
3) Borrowed funds: loans, lines of credit, family gifts with repayment terms required. The monthly payments for the borrowed money will be used in your debt-serviceability ratios: effectively, if you have many payments or large payments, these could hold you back from purchasing the home that you want.
4) Sweat equity: very uncommon for a lender to use this as a downpayment option, but in some rare cases, it will be considered.
For the most part, the vast majority of mortgage seekers that we work across Canada have a clear understanding of what is required to meet the downpayment requirements to make the gears turn and successfully complete their mortgage application and obtain a complete approval from lenders. Having said this, from time to time, we see some headaches pop up from borrowers’ inability to clearly prove where their downpayment money is coming from. Some of the most common ‘speedbumps’ that we run into are:
- the downpayment is coming from a friend or a non-arm’s length source. This is not acceptable.
- the downpayment is coming from cash with no 90-day bank account history of the accumulation of the funds over the past 90 days. This looks like money laundering and is unacceptable.
- in the case of an estate settlement, business dissolution or if the funds are coming from the proceeds of a divorce, lenders will always ask for written proof that there isn’t any form of outside influence, reciprocity, interest or potential for a clawback of the downpayment funds being used: no one – especially the lender – wants to be put offside (legally) by a third party claiming rights to the funds or the property.
- The “good deal” scenario: Just because a home buyer finds a good deal – maybe a distress sale or a foreclosed proeprty – ‘A’ or ‘best rates and terms’ lenders make it their policy to lend on the purchase price, not the market value. If the market value happens to be greater than the purchase price, the ‘excess’ is basically seen by lenders as ‘congratulations, you got a good deal’ and not as ‘let’s use that as equity’ because it’s a speculative gain. In this case, borrowers will have to still come up with at least 5% on the purchase price of the property and run the numbers that way. Sweat equity is seen from a similar perspective in many ways, as are homebuilder price reductions or price-adjustment incentives: they’re truly not ‘added value’ or ‘free money’ until you sell the property.
Do you have any questions or concerns related to your own circumstances when it comes to downpayment? Leave a comment here on this post, send us a message via our Contact Us page or send me an email at james(a)trimormoney.com and I”ll be happy to help you walk through the ins and outs of your unique situation.
Helping increase your financial fluency to make your next purchase or refinance transaction run smoothly,
James C. Tworek and the Trimor team!
www.TrimorMoney.com and www.CalgaryMortgageBlog.ca
