When a lender is confronted with a borrower seeking financing they are looking for the 4 Cs of borrowing. In a post entitled “What is the Greatest Obstacle to Borrowing Money to Purchase a House?” I explained what the 4 Cs of borrowing are. In this post I intend to get much more specific as to what a lender is looking for in the category of Collateral.
When considering a borrower’s Collateral, lenders are looking at the total value of a borrower’s financial assets. However, in a purchase transaction, the lender is primarily concerned with the amount of the down payment – the amount of money a borrower invests in the house at the time of the purchase.
Collateral placed inside the house in the form of a down payment helps protect the lender in the event of foreclosure. If a borrower is unable to make the monthly mortgage payments for three or more consecutive months the lender reserves the right to sell the house to recover the money it loaned to a borrower.
Generally speaking, a lender wants to see that a borrower has sufficient assets to cover the following:
- Down payment – This amount can range from as low as zero down payment, as in VA & USDA loans, 3.5% of the purchase price, as with a FHA loan, or 5% to 20% or more of the purchase price, as with a conventional loan.
- Recurring closing costs – These include costs such as interest, homeowners insurance, and property taxes.
- Non-recurring closing costs – These costs include, but are not limited to, the appraisal fee, credit report fee, processing fee, underwriting fee, escrow fee, title fee, and recording fee.
- Reserves – This amount is typically equal to the first two monthly mortgage payments. Not all loan programs require reserves.
For funds to be considered acceptable they must come from a legal and verifiable source. The list of verifiable sources include, but is not limited to, checking accounts, savings accounts, money market accounts, brokerage accounts, qualified and non-qualified retirement accounts, insurance cash value, inheritances, gifts, etc…
In a refinance transaction your collateral includes all the sources mentioned above, as well as the amount of your equity, which is the difference between what your home is worth at any given time and the total of any outstanding mortgages at that time.
Collateral outside the house, such as financial assets, protects a borrower first, and helps that borrower maintain use and control of the house indirectly. The lender likes to see that a borrower has collateral to weather any financial storms that might present themselves, whether expectedly or unexpectedly.
Key Understanding: Once collateral is placed inside the house, whether by a down payment or monthly principal payments, there are only two ways to get that collateral back out of the house in the event the borrower needs access to it: 1) sell the house, or 2) refinance.
If you’re interested in learning more about what it takes to purchase a home of your own, you’ll want to read other posts in the series, such as So, You Want to Buy a House?, The Power of Pre-Approval vs Prequalification, What is the Greatest Obstacle to Borrowing Money to Purchase a House?, What Are Lenders Looking For? Character!, What Are Lenders Looking For? Capacity!, What Are Lenders Looking For? Credit!, The Two Approvals, and more.
If you’re interested in learning more about what to consider before paying cash for any major capital purchase, download our FREE report entitled “Is Paying Cash Detrimental to Your Financial Health?” We also encourage you to contact us to schedule a time to talk about your specific circumstances.
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