Cash offers have traditionally been a great way to get a discount or encourage a reluctant seller. However, when it comes to mortgages, cash can suddenly lose its appeal. Nowadays, lenders want to know exactly where all your funds are coming from.
For instance, using undocumented cash funds could create unexpected issues in a real estate transaction. Specifically, if you’re hoping to use cash that was deposited into your bank account to contribute to the down payment, you might want to reconsider. That’s because using cash for home deposits could look like fraud and affect your chances of getting a mortgage.
So, while cash may be king with home sellers and their real estate agents, the same is not true with financial institutions. Therefore, when purchasing a home — especially for the first time — buyers should have a strong grasp of how lenders treat deposits.
Let’s take a look at the considerations surrounding cash earnest money deposits when buying a property.
Verifying Cash Deposits
You can get cash from anywhere and deposit it into your account. But, when purchasing a home, you will have to prove that you received the cash through legal sources.
In particular, the lender needs to confirm that the money was obtained through legal means and that it isn’t a loan. Accordingly, they will verify any money you have on hand (in addition to your income). If they are unsure of the source of a deposit, it could look fraudulent. For example, unverified deposits may cause the lender to suspect that you are using borrowed money to make your application more successful; making misleading statements about your employment; or borrowing money from the seller to make the down payment.
However, fraud isn’t the only issue that lenders are looking to stop. They are also concerned with money laundering, the funding of illegal groups that may be related to terrorism and any other illegal acts. If the lender suspects any problems like this, they are required to report it to the appropriate government agency.
Qualifying for a Mortgage
When you apply for a mortgage, the loan officer will review your income and compare it to your monthly expenses, which is your debt-to-income ratio — the lower the ratio, the better.
Typically, to be eligible for a mortgage, your debt-to-income ratio must be 43% or less. And, any cash deposits that are actually loans will add to your debt, thereby increasing your ratio. Plus, you may be liable for fraud if you neglect to claim that a cash deposit is from a loan. Some lenders may not even allow you to have any other loans when you apply.
Proving the Source of Your Cash
Unfortunately, it can be difficult to prove where cash deposits came from. Undoubtedly, you will need to provide your lender with paperwork that proves the source of the deposit. Exact requirements will vary by lender, but may include:
- Pay stubs from your employer
- A gift letter signed by all parties, including the donor and receiver
- A detailed report of any sale in which you made a profit
- A signed, dated copy of any loan you provided and proof that you lent the money
- A letter of explanation from a licensed attorney
Gifts Toward the Down Payment
Down-payment gifts are actually allowed by most lenders — you may just have to prove that it is a gift and not a debt that you would need to repay. To prove that a gift is genuine, provide your lender with solid evidence, such as a letter from the person who gave the gift, as well as proof of the transfer of funds, like a deposit slip or transfer receipt.
Gifts that come from family members are usually fine. But, if the person has a significant interest in the property, it could violate the law. As such, it is essential to note here that any seller, builder, developer, real estate agent or anyone else with a clear interest in the mortgage is not allowed to gift funds to the buyer.
Simplified Cash Deposits
Fortunately, lenders only review the last 60 days of transactions in your account, so deposits prior to that time do not need to be accounted for. Although this money still needs to be acquired legally, lenders will not request evidence of the source for deposits made more than 60 days ago.
However, deposits of $10,000 or more will have to be reported to the IRS whenever they take place. You can’t get around this by splitting up deposits into smaller amounts, either — they will still be reported.
Consequently, if you do need to make a deposit in the 60-day window, inform the lender and ask for their advice on the requirements. Then, be sure to keep any accompanying documentation of the cash deposit so that you will have it if or when they ask for it. Likewise, if the source of the cash will be difficult to prove, you may be better off not depositing the money. And, if you are unsure of the situation with the money you are hoping to deposit, check with your lender before putting it into your account.
Cash transactions could hinder the buying process. So, if you can’t avoid them, contact your lender or mortgage broker to ensure that you stay within their requirements so as not to compromise the mortgage.
Although utilizing cash deposits when buying a home is not forbidden, they may present some challenges if you are unprepared for them. Therefore, it’s essential to understand the importance of always having documentation of the source of the funds when using cash.