With companies such as SMR Research predicting a quick rise in mortgage rates over the next couple of years, many first-time homebuyers are looking to snap up a home now. If you’re one of them, you may be struggling to figure out how to gather up a down payment so that you can buy a home before the rates start climbing back up.
You may have several options for a down payment, including a tax refund check, a gift from a family member, or even cashing out your IRA. Then, of course, there’s the traditional route of just save, save, saving until you have enough for a down payment.
Many first-time homebuyers, especially, use a combination of these approaches because saving a lot of money for a down payment can be tough, to say the least, when you're renting. Regardless of how you're planning to fund your down payment, keep in mind that certain types of down payment funds may need to be "seasoned."
Why Money Can’t Appear Out of Thin Air
We all know money doesn’t grow on trees. But it’s especially important when it comes to buying a home that your down payment doesn’t just suddenly appear.
Sure, you might get a windfall from a side job, a bonus check, or an unexpected gift from a relative. But you may not be able to run out and put that windfall down on a home.
For lenders, the main goal is to protect against potential default. That’s why they require a detailed paper trail so that they know exactly where your assets are coming from. That’s also why lenders check your credit score and make sure you have adequate income to cover a home purchase. If you have good credit and a decent debt-to-income ratio, the lender can be relatively sure that you’ll be able to keep making payments on your mortgage, rather than defaulting on your loan.
Lenders also want to ensure that you aren’t getting money from a second loan when you turn in your down payment. While you can sometimes take out two loans on one property, lenders generally shy away from this, particularly with today’s stricter lending standards.
It works this way: If you've taken two loans, another lender may have a claim on your property if you default, and that's not a good situation for either lender. Plus, an extra loan would change your debt-to-income ratio, which might disqualify you for the loan you want.
All this means that lenders want to know exactly where the money for your down payment is coming from. Money that just appears in your bank account isn’t going to cut it, even if it’s from a legitimate source.
What are Seasoned Funds?
To avoid questions from lenders, you may want to use “seasoned funds” for your down payment. Basically, seasoned funds are funds that have been in your bank account for at least the last 60 days.
“Seasoning” funds is easy. You just get your money together, stick it in a bank account (a separate account for your down payment is often preferable), and wait 60 days before you apply for a loan.
Most lenders will check your bank account statements for the last two months, and when they see the funds have been there for that long, they'll assume the money is yours and legitimately sourced.
Plus, the 60-day waiting period is enough time for an extra loan to pop up on your credit report. If you did take out a personal loan for your down payment, your lender will know about it from your credit report. So don’t try to trick a lender this way.
When Funds Don't Need to Be Seasoned
Seasoning the funds in your bank account will smooth out the lending process, so it’s best if you can deposit any money you need for your down payment, and then wait 60 days before applying for a loan.
But you don’t always need to season funds before applying for a loan. Here are some situations in which seasoning might not apply:
- Payroll deductions. If you’re saving a good chunk of every paycheck in order to buy a home, you don’t have to wait 60 days after you have enough money in your account for a down payment. Your lender will easily be able to see that you have a savings pattern in place and that the money comes from your paycheck, making it yours automatically, without having to season the funds.
- Retirement funds. In some cases, you can cash out your retirement funds penalty-free (though you may still have to pay taxes) for first-time homebuying (or building or re-building) expenses. If you can prove that this money is coming from a legitimate retirement fund source in your own name, you won’t have to season those funds. In fact, you won’t want to season those funds because money withdrawn from an IRA for homebuying expenses must be used within 120 days to avoid the penalty.
- Gift funds. If someone is helping you buy a home with a gift, you don’t have to season those funds, provided you have a proper paper trail showing where the gift money is from. However, the person giving you the funds may have to season them in their account before transferring the money to you. This is to ensure that the giver didn’t take out a loan to give you money for a down payment, expecting you to pay the loan back eventually.
The bottom line here is that if you aren’t absolutely positive a lender will accept your down payment funds, check with your lender first. Consider meeting with potential lenders three or four months before you plan to buy a home to discuss your funding and other details of your home loan.