This is the start of a new series that will explain key requirements for FHA loans, as we move into 2014. The Department of Housing and Urban Development (HUD) establishes all of the guidelines for this loan program, and they revise those guidelines from time to time.
So we are going straight to the source — that is, HUD Handbook 4155.1 — to get the latest rules, regulations and requirements for this ever-popular loan program.
This update explains the acceptable sources of funds for FHA down payments and closing costs, and is current through 2014.
Borrowers Must Have Sufficient Funds to Close
The Federal Housing Administration (FHA) offers several financing options, ranging from the standard FHA loan used for purchases to the 203K home-improvement loan. For most of these mortgage products, borrowers are required to make a down payment equal to or greater than 3.5% of the purchase price or appraised value, whichever is less.
FHA borrowers must also have enough money in the bank to cover their closing costs and other fees due upon settlement.
The borrower’s funds used for both the down payment and closing costs must come from acceptable sources. You will find a list of these acceptable sources below. Additionally, the mortgage lender must thoroughly verify and document the funds prior to closing. Funds from unauthorized sources, such as a salary advance, may not be used to qualify the borrower for an FHA loan.
References: HUD 4155.1, Chapter 5, Sections A and B
Acceptable Sources for Down Payment and Closing Cost Funds
Most legitimate sources of income and wealth are acceptable for FHA purposes. HUD allows a wide range of funding sources, as not to exclude borrowers with non-traditional income or revenue. The following sources of funds may be used to qualify for an FHA loan in 2014:
- Savings and checking account funds
- The borrower’s earnest money deposit
- Cash saved at home (that was never deposited into a bank)
- Cash accumulated through a private savings club
- Gift funds provided by a family member, employer, charitable organization, or a government buyer-assistance program
- Savings bonds
- Investment / retirement accounts (401k, IRA, Keogh)
- Stocks and bonds
- Thrift savings plans
- Proceeds from the sale of another home or personal property
- Proceeds from the sale of other personal property
- Commissions from a sale
- Trade equity
- Income / equity generated from a rental property
- Sweat equity (property value generated by home improvement, remodeling, etc.)
- Certain types of grants and loans
- Collateralized loans
- Employer assistance plans or guarantee plans
Using Cash That Was Saved at Home
Some mortgage programs discourage the use of money saved at home, or “mattress money,” for down payments and closing costs. Instead, these lenders prefer borrowers to use funds in a traceable bank account. This allows the lender to trace the money back to its source, to some extent. This practice is known as “sourcing.”
In contrast, borrowers using the FHA loan program are permitted to use money saved at home. According to HUD’s guidelines for 2014, borrowers who “have saved cash at home, and are able to adequately demonstrate the ability to do so, are permitted to have this money included as an acceptable source of funds to close the mortgage.”
As always, there are stipulations. Before it can be used as a source of down payment and closing-cost funds, cash saved at home must be verified in some way. This can be accomplished by (A) depositing the money into a bank or other financial institution, or (B) having it held by an escrow or title company.
Additionally, FHA borrowers must show “satisfactory evidence” of their ability to save money. Borrowers must explain, in writing, how the cash was accumulated and how long it took to do so.
This is where mortgage lenders must put on their detective hats. HUD requires lenders to determine whether the money saved at home is realistic, based on (A) the time period during which it was accumulated, and (B) the borrower’s spending habits and income stream. If the cash seemingly “came out of nowhere,” with no logical explanation or source, it probably won’t be considered an acceptable source of funds for down payment or closing costs.
Using Investments: IRA, 401(k), Keogh, Stocks and Bonds
Certain types of investment and retirement accounts can also be used as down payment and closing-cost funds on FHA loans. These include 401(k) accounts, thrift savings plans, IRAs, and Keogh accounts.
According to HUD’s guidelines for 2013 – 2014, up to 60% of the value of these assets can be used for FHA mortgage underwriting. In other words, up to 60% of the borrower’s investment worth can be used as closing cost and down-payment funds. A higher percentage may be allowable if the borrower can prove that the higher amount can be withdrawn (minus any withdrawal penalties and income taxes).
In the next part of this series, we will examine the latest standards and requirements for down-payment gifts.
Disclaimer: This article explains the acceptable sources of funds that can be used for closing costs and down payments on FHA-insured mortgages. This information was adapted from official HUD guidelines and is current through the first quarter of 2014, after which it will be reviewed for accuracy. For the latest and most accurate information on this loan program, please visit www.HUD.gov.