In the 1980s, there was this video game called “Pitfall.” To beat the game, you had to traverse various levels while avoiding the big black holes that would lead to your character’s demise. The more you played it, the more you got used to the challenges. You could plan ahead.
The mortgage process is the same way. It’s easier to avoid the pitfalls if you know what to expect. You can have a game plan to avoid them.
I spoke with Quicken Loans Senior Purchase Banker Patrick O’Connor about the most common challenges clients face and how a little preparedness can help you avoid missteps.
Normally when we get a gift, we’re not supposed to consciously keep track of its value. That’s not the point. We’re taught to just let friends and family do something nice for us.
With a down payment gift, you absolutely need to document everything.
“A lot of times people are getting gift funds to purchase a home,” O’Connor said. “Maybe they’re not initially looking to do that, but a family member finds out they’re buying a home and wants to help out. We have to show a paper trail for all the money that’s gone into their account for the last 60 days.”
You can’t bring recently deposited cash to the closing table. It can sometimes complicate things because the cash used for close has to be documented and in your account for a period of time. If it isn’t, you may not be able to use those funds to finish the loan process.
Avoiding a Sour Gift
So how do you avoid a problem and still let someone help you with your down payment? Start getting everything down on paper in the form of a gift letter.
The gift letter should include, among other things, the amount of money being gifted and who or where it’s coming from, as well as a statement that the funds don’t have to be paid back.
On an FHA loan, lenders also need to see bank statements from the donor showing that they had the funds in their account for at least 30 days prior to the gift.
What do you do if you suddenly come into some money – maybe from your birthday or the holidays – that you would otherwise put toward your down payment, but can’t document on short notice?
O’Connor recommends you spend this money by taking a page out of Destiny’s Child’s book and start paying those “bills, bills, bills.”
While this can be a helpful guideline, you also don’t want to pay off something like your car or student loans in full with that money before closing. Funds used for the purpose of fully paying off accounts have to be documented.
“Avoid cash deposits that are around $400 or $500 or even a series that adds up to that,” he said. “Spend saved up cash on bills so you can have sourced paychecks build up in your account.”
Another common issue O’Connor said people run into is when they sell assets in order to quickly boost the funds available for a down payment. If it’s your stuff, what’s the problem?
First, you can’t sell that pool table your wife wants you to get rid of for cash. The transfer has to be somehow documentable in the form of a check or other transfer medium that leaves a paper trail.
The second and perhaps more sticky issue is that you have to be able to document that what you’re selling was indeed yours to sell. Otherwise, the lender has to treat it like a loan, which can’t be used for a down payment.
Things like selling your used car are easier than selling something like furniture because you have a title and a bill of sale to which you can point back. Maybe you have the receipt for the pool table and a way of documenting things, but probably not. You also have to be able to show its value.
The last important thing we’ll cover around sourced funds here are reserves. Reserves are evidence that you have the money to make your mortgage payment for a while if you lose your job or experience some other hardship.
What’s covered in your reserves and your mortgage payment in general is best remembered by the acronym PITIA. Since I “pity the fool” who doesn’t understand what PITIA stands for, let’s briefly cover it here.
- Homeowners insurance
- Homeowners association dues (if applicable)
Depending on the type of loan you get, reserves may be required. Even if they aren’t, O’Connor said having a couple months of payments can strengthen your case for approval because you look better prepared.
If a client has an appraisal come back lower than expected, it can cause an issue during the buying process because you can’t get a mortgage for more than the value of the house.
If this is the case, O’Connor said clients have some options. The first two may not be preferable: walk away from the deal or bring the difference between the appraisal and the purchase price to closing.
There is a third option, however. You can work to renegotiate the deal with the seller. If they are serious about moving, they probably don’t want to have you back out of the deal. You also have some additional leverage because you can now point to a document that gives the house a definitive value that’s lower than the sale price.
Dodging Credit Conundrums
It’s also important to avoid doing anything that could cause a potential credit hit during the mortgage process. This is particularly important if it takes longer. You could have a bit of trouble finding a house, for instance.
Lenders try not to pull credit more than once. However, one of the more common reasons they might have to do it is if your credit report expires due to a longer loan process.
If it takes a little longer, you don’t really have to worry as long as you don’t take on any new debt that could mess with your credit report or debt-to-income (DTI) ratio. This means not buying a new car and not opening up any new credit accounts until after the loan is closed, no matter how tempting the financing deals may seem when you’re shopping for appliances.
You should also avoid charging more to credit cards and using and using too much of your available credit at any time as this can drop your score. A good guideline is to use no more than 30% of your available credit on a monthly basis. The key is really to try to maintain a status quo in your credit during the buying process.
Hopefully these tips help you get a head start in the mortgage game so you can level up and get into your own home. Here’s some more advice on closing your loan smoothly. If you still have questions, we’d be happy to answer them in the comments.
If so, subscribe now for tips on home, money, and life delivered straight to your inbox.