Why Downpayment Source Matters

If you’re looking to purchase a property, although you might

not think it matters too much, the source of your

downpayment means a great deal to the lender. Let’s discuss

the lender requirements, what your downpayment tells the

lender about your financial situation, a how downpayment

helps establish the mortgage loan to value.


Anti-money laundering


Lenders care about your downpayment source because,

legally, they have to. To prevent money laundering, lenders

have to document the source of the downpayment on every

home purchase.


Acceptable forms of downpayment are money from your

resources, borrowed funds through an insured program called

the FlexDown, or money you receive as a gift from an

immediate family member.


To prove the funds are from your resources and not laundered

money from the proceeds of crime, you’ll be required to

provide bank statements showing the money has been in your

account for at least 90 days or that you’ve accumulated the

funds through payroll deposits or other acceptable means.


Now, if you’re borrowing all or part of your downpayment,

you’ll need to include the costs of carrying the payments on the

borrowed downpayment in your debt service ratios. If you’re

the recipient of a gift from a direct family member, you’ll need

to provide a signed gift letter indicating that the funds are a

true gift and have no schedule for repayment. From there,

you’ll need to show the money deposit into your account.


Financial suitability


Lenders care about the source of the downpayment because it

is an indicator that you are financially able to purchase the

property.


Showing the lender that your downpayment is coming from

your resources is the best. This demonstrates that you have

positive cash flow and that you’re able to save money and

manage your finances in a way that indicates you’ll most likely

make your mortgage payments on time. If your downpayment

is borrowed or from a gift, there’s a chance that they’ll want to

scrutinize the rest of your application more closely.


The bigger your downpayment, the better, well, as far as the

lender is concerned. The way they see it, there is a direct

correlation between how much money you have as equity to

the likelihood you will or won’t default on their mortgage.

Essentially, the more equity you have, the less likely you will

walk away from the mortgage, which lessens their risk.


Downpayment establishes the loan to value (LTV)


Thirdly, your downpayment establishes the loan to value ratio.

The loan to value ratio or LTV is the percentage of the

property’s value compared to the mortgage amount. In

Canada, a lender cannot lend more than 95% of a property’s

value. So, if you’re buying a home for $400k, the lender can

lend $380k, and you’re responsible for coming up with 5%, $

20k in this situation.


But you might be asking yourself, how does the source of the

downpayment impact LTV? Great question, and to answer this,

we have to look at how to establish property value. Simply put,

something is worth what someone is willing to pay for it and

what someone is willing to sell it for. Of course, within reason,

having no external factors coming into play. When dealing with

real estate, an appraisal of the property will include

comparisons of what other people have agreed to pay for

similar properties in the past.


You’ll often hear of situations where buyers and sellers try to

inflate the sale price to help finalize the transaction artificially.

Any scenario where the buyer isn’t coming up with all of the

money for the downpayment, independent of the seller,

impacts the LTV.


All details of a real estate transaction purchase and sale have

to be disclosed to the lender. If there’s any money transferring

behind the scenes, this impacts the LTV, and the lender won’t

proceed with financing. Non-disclosure to the lender is

mortgage fraud.


So there you have it; hopefully, this provides context to why

lenders ask for documents to prove the source of your

downpayment. If you’d like to talk about mortgage financing,

please connect anytime; it would be a pleasure to work with

you.

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