Cash to Close - A Basic Primer

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Cash to close has always been an underwriting standard, but more people are running into it as a reason why they cannot buy that property, why their buyers cannot perform, and why they can't get that refinance approved. With lender requirements as to what they will and will not loan on, not to mention impacted equity situations, "cash to close" has become more important than it was, when for about fifteen years it was barely on the radar. Whether you are a buyer, seller, agent for either, loan officer, or someone who wants to refinance the property you already own, you need to be aware of the requirements for "How much cash needs to be there to make this loan happen?" If you anticipate them and structure the transaction correctly, said transaction will have a lot fewer stumbling points.

During the Era of Make-Believe Loans, 100% financing was routine, and with seller paid closing costs, the buyers often literally did not need a penny to buy property. Indeed, such was one reason the real estate market got so wildly out of hand. Not the only reason, nor the main one, but when people could believably say, "You haven't got any money in it, so just walk away if anything goes wrong," they could get a lot of takers, even when that's a lie precisely equivalent to the con man's "trust me!"

Right now, the only generally available 100% financing is the VA loan. 100% stated income financing, which was the gravy train for many god-awful real estate agents and loan officers, might as well be story on the lines of a Greek myth in the current environment - stories of what they called hubris abound in Greek Mythology.

Furthermore, lenders are looking hard at seller paid closing costs. They're desperate to make what they think of as good loans, so they're still mostly giving these a pass - but there are more instances of snags with them now than I can remember hearing of at any time in the recent past.

The upshot is that you have to consider "Cash to Close." You have to remember it and keep it always just as much in mind as loan to value ratio, credit score and debt to income ratio. Not only do you have to have the money for the down payment, you've got to have all the cash you need to close the transaction. This is a prior to documents condition: the lender will not so much as generate loan documents for signature until you and your loan officer can demonstrate that you have enough cash to actually make the down payment and everything else that you are going to need to pay to make the transaction happen.

The largest component of all is usually the down payment: 3.5% or more of the purchase price for FHA financing, 5 to 20 percent or more for conventional financing, depending upon what's available to you and some choices that get made. 5% down has become more available for conventional financing again as mortgage insurers have started insuring those loans again, and these loans all require private mortgage insurance unless and until the down payment reaches 20% of the purchase price. There are exceptions in some municipal first time buyer programs, but those are not "generally available" in that they run out of money at Warp Speed whenever they do get an allotment.

Closing costs for the loan are another component of cash to close. It takes money to pay the people and companies working on your loan. For a rule of thumb, I use $3500 even though it's probably going to be less than that, excluding discount points, which are used to buy the rate down, and impound account money. Title insurance, escrow fees, appraisal, processing fees, lender fees of various kinds, government fees such as recording, and usually a charge for origination, itself usually measured in points. These all have to get paid, or your loan doesn't get done. Nobody is going to agree to pay these costs for you unless they get something for it in the form of a higher interest rate.

There is always a tradeoff between rate and cost in real estate loans - you don't get a lower rate without paying for it, and you don't get costs paid for without agreeing to a higher rate in exchange. Points are measured as a percentage of the gross loan amount. If, for example, you're paying two points to buy the loan rate down, then after you've added in all the closing costs and impound fees and anything else that applies, this amount is only 98% of your total loan amount. On purchases, you're going to have to have this two percent of the loan amount in cash if you want to buy that rate down, effectively adding to your down payment requirements. So even though I've taken this slightly out of order here, in reality, points are the last things figured into the loan, assuming that there are any.

Impound accounts are seed money for paying your property taxes and homeowner's insurance, giving the lender assurance that they will be paid on time and in full, thereby not jeopardizing the lender's interest in your property through unpaid property taxes or having the property damaged or destroyed while uninsured. Many people like having these details taken care of by just writing a slightly larger monthly check in the first place. They are your money, but the lender wants enough money to seed these accounts so that they will have enough in them to pay these charges when they are due. As I have said and demonstrated, impound accounts can be several thousand dollars, and lenders can, in many states, charge extra for not having them.

Finally, there are the buyer costs of the purchase. Around here, they really aren't much - half the purchase escrow, recording costs and a few other minor things. I generally include them in the closing costs of the loan (as above), but they really are different. In other areas of the country, however, the rules are different and the traditions are that the buyers pay more of the costs of transference. Neither way is necessarily right or necessarily wrong; it's more a matter of what everybody is used to, and the fact that the usual method for your area is what the rest of the market is priced for.

On purchases, all of this money can only come from cash in addition to the down payment, or by moving cash away from money that would otherwise be used for the down payment. For refinances, if there is enough equity then these costs can usually be rolled into your new loan amount - but do not confuse that with not paying those costs. You are not only paying all of those costs, you are paying interest on them and they are still in your loan balance until you find enough in the way of payments to pay them off. Don't Roll Mortgage Refinance Costs Into Your Balance If You Wouldn't Pay Them Cash. And to further drive this point home, as many people are discovering now that they don't have this equity on refinancing, they are having to come up with thousands of dollars if they hope to get that loan actually funded. Real refinancing is not a case of blindly rolling what may potentially be tens of thousands of dollars into your loan balance. It's okay if you have the equity and make a conscious choice that this is the best way to handle it for you; it is not okay if by doing so you merely get to pretend that it isn't real money.

Down payment plus closing costs plus impounds plus buyer costs, plus points (if any) equals cash to close. You need to have this money available in cash, and you have to be able to convince the loan underwriter of its provenance - sourcing or seasoning the funds. Where did all of this money come from? The lender wants to know that it is not from an undisclosed loan, which you're going to have to make payments on, possibly thereby putting the entire transaction into the realm of unaffordability because your debt service is now too high a proportion of your income. You are going to have to show you got the money from some source that is not a loan, or that you have built it up and saved it over time. The lender is going to ask for supporting documentation, of course. For refinancing, there is at least potentially a little more leeway, if you've got equity in the property you can borrow further against that equity as an equivalent to cash, in order to close that loan. But that is a very different thing from not needing the cash in the first place, which is a pipe dream. For purchases, this very elementary, completely foreseeable difficulty is probably at fault in at least half of the transactions that are failing to close - all because lazy agents and loan officers got used to sloppy practices and are having difficulty weaning themselves away. Cash to close is real, and it's something that everyone needs to concern themselves with, lest they be made very unhappy when the entire transaction falls apart because the cash to close wasn't there to begin with.

Caveat Emptor

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About this Entry

This page contains a single entry by Dan Melson published on November 16, 2019 7:00 AM.

Homesteading and Declaration of Homestead was the previous entry in this blog.

Legal Reasons for Making Late Payments on Your Mortgage is the next entry in this blog.

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