Closing Costs and Reserves
The necessary part of any closing are the closing costs that are required in addition to your down payment amount.
The Capital Component: Closing Costs, Prepaid Escrow, and Reserves
Successfully navigating closing costs and reserves is the final validation of a mortgage application. This module clarifies the exact money needed to close and the strict rules governing where those funds originate.
I. Cash to Close: Fees vs. Prepaids
"Closing Costs" is a broad term. In reality, the cash needed at closing is split into two distinct and financially different categories: Non-Recurring Closing Costs (True Fees) and Prepaid Expenses (Escrow Setup).
Non-Recurring Closing Costs (True Fees)
These are one-time costs paid to third parties for services rendered to originate the loan or transfer the property. They do not recur after closing.
- Origination Fee/Points: Paid to the lender/broker for processing and issuing the loan.
- Appraisal Fee: Paid to the third-party appraiser.
- Title Insurance & Closing Fees: Paid for insuring the property title and managing the closing transaction.
- Credit Report/Underwriting Fees: Administrative costs charged by the lender.
Prepaid Expenses (Escrow Setup)
These are payments for items that belong to the borrower but must be paid in advance or collected to set up the Escrow account.
- Property Taxes: Funds collected for the initial 2-3 months plus any proration due to the seller.
- Homeowners Insurance (HOI): Must pay the first full year premium up front.
- Escrow Reserve Cushion: An additional 2 months of PITI (Principal, Interest, Taxes, Insurance) payments held in reserve, required by law.
- Pre-Paid Interest: Interest due from the closing date through the end of the current month.
Crucial Insight: While non-recurring fees are true expenses, prepaids are essentially a forced savings plan. These prepaid items establish the Escrow Account, from which the lender pays your taxes and insurance monthly, ensuring compliance and protection.
II. Asset Verification: Source, Seasoning, and Large Deposits
Underwriters must verify not only the existence of funds but also the source of those funds to prevent money laundering and ensure no undisclosed debt was incurred to obtain the down payment.
The Rule of Seasoning and Large Deposits
Quick Reference: Funds Verification Rules
- Seasoning: Funds are considered "seasoned" if they have been in the borrower's verified bank account for at least 60 days (two full bank statements). Seasoned funds do not require source documentation.
- Large Deposits: Any single deposit that exceeds 50% of the borrower's total gross monthly income and is **not seasoned** must be documented and explained (sourced).
- Acceptable Sources: W-2 payroll, verifiable transfers between borrower accounts, liquidation of securities (with full transaction history), and acceptable gift funds.
- Unacceptable Sources: Cash on hand, large deposits without source documentation, undisclosed loans, and funds received from parties with an interest in the transaction (e.g., the seller or builder).
III. Gift Funds and Post-Closing Reserve Requirements
Underwriting Rules for Gift Funds
Gifts are a primary source of down payment funds, but they must meet specific criteria to be used.
- Required Documentation: A Gift Letter signed by both the donor and the borrower, stating the funds are a gift (no expectation of repayment).
- Donor Eligibility: The donor must be a relative (family member) or someone considered close to the borrower (e.g., fiancé, domestic partner). Donors may not be parties interested in the transaction (e.g., seller, real estate agent, builder).
- Donor's Source of Funds: The lender must obtain bank statements from the donor to verify they had the funds available before gifting them. The donor's funds must also be verifiable and not large, unsourced cash deposits.
- Down Payment Limits: For conventional loans, if the down payment is less than 20%, the entire down payment can be a gift. If the down payment is 20% or more, gift funds can cover the entire amount. FHA rules allow 100% of the required funds to be gifted.
Financial Reserves (The Safety Net)
Reserves are funds remaining in the borrower's accounts **after** closing, measured in months of the total PITI payment. They demonstrate financial stability.
Mandatory Reserve Scenarios
The requirement for reserves varies based on risk factors, property type, and DTI. Reserves are calculated as: Total Available Assets / PITI Payment.
- Primary Residence: Typically, 0-2 months of reserves are required, but this increases with lower credit scores or higher DTI.
- Investment Properties: A minimum of 6 months of PITI reserves is usually mandatory for investment property loans, regardless of other factors.
- Jumbo Loans: These loans typically require the highest reserves, often demanding 6, 9, or even 12 months of PITI.
Capital Is Covered. Time to Review Loan Products.
With the 3 C's of underwriting complete (Credit, Capacity/Income, and Capital), we move to the final essential step: analyzing the major mortgage product types available today.
Move On to Module 9: Comprehensive Loan Program Analysis →Trusted, Local, and Licensed in Florida
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