Why Downpayment Source Matters

If you’re looking to buy a home, although you might think it doesn’t matter too much, the sources of your down payment means a big deal to the lender. Let’s talk about the lenders’ requirements, what your down payment tells the lender about your financial situation, and how a down payment helps determine the mortgage loan to value ratio.

Anti-money laundering

Legally, lenders have to know the sources of your down payment. In order to help prevent money laundering, lenders have to document the sources of the down payment on every property transaction.

Acceptable forms of down payment are money from your own resources such as funds in your chequing, savings, TFSAs, RRSPs. Other forms of acceptable down payment includes borrowed funds through an insured program called the FlexDown. Finally, money you receive as a gift from an immediate family member is also acceptable.

In order to prove the funds are from your own resources and not laundered money from criminal activities, you’ll be required to show bank statements showing the money has been in your account for at least 90 days or that you’ve collected the funds needed for the down payment through using an automatic savings plan, payroll deposits, investing, or other acceptable means.

Now, if you’re borrowing all or part of your down payment, you’ll have to include the costs of carrying the payments on the borrowed funds in your debt service ratios. If you’re the recipient of a gift from a direct family member such as from your parents, you’ll need to provide a signed gift letter indicating that the funds are a true gift and that you have no schedule for repayment. From there, you’ll have to show the money deposited into your account.

Financial suitability

Lenders care about the sources of the down payment because it is an indicator that shows your financial ability to afford to buy a property.

Showing the lender that your down payment is coming from own your resources is the best. This demonstrates that you have positive cash flow (making more than you spend). In addition, this shows that you’re saving money and managing your finances properly in a way that indicates you’ll most likely make your mortgage payments on time. If your down payment is from a gift or borrowed, there’s a chance that they’ll want to examine the rest of your mortgage application more carefully.

The bigger your down payment, the better it is, as far as the lender is concerned. The way they see it is there is a direct correlation between how much money you have as equity to the likelihood you will or won’t default on the mortgage payment. Basically, the more equity you have in the property, the less likely you are to default, which lowers their risk.

Downpayment establishes the loan to value ratio (LTV)

Thirdly, your down payment 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 $500k, the lender can lend $475k, and you’re responsible for coming up with 5%, $25k in this case.

You might be wondering, how does the source of the down payment impact LTV? Great question, and to answer this, we must look at how to determine 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 down payment, independent of the seller, impacts the LTV.

All details of a real estate transaction purchase and sale must be disclosed to the lender. If there’s any money transferring behind the scenes, this will impact the LTV, and the lender won’t go through with financing. Non-disclosure to the lender is mortgage fraud.

So, there you have it. Hopefully, this provides clearer picture on why lenders ask for documents to prove the sources of your down payment. If you’d like to talk about mortgage financing, please contact me anytime. It would be a pleasure to work with you.