There's a long list of documentation real estate investors should be prepared to come up with before being able to close on a purchase transaction. Some you'll need later on in the closing process, while others may be required before you can even get a seller to agree to terms.
One document that often falls into the latter category is known as a proof of funds letter. This document is extremely important when negotiating a home purchase, as it can show a seller that you're a serious buyer who is actually capable of buying the property, especially if you're a cash buyer and aren't planning to obtain a mortgage.
With that in mind, here's what all real estate investors and homebuyers need to know about proof of funds letters, what types of funds can be used to provide proof, and how to go about getting a proof of funds letter before you submit your next offer.
What is a proof of funds letter?
In simple terms, a proof of funds letter is a document that shows you have enough cash or other liquid assets to purchase a property. This document shows sellers that you're not only a serious buyer, but that you have enough money to actually follow through on the purchase.
A proof of funds letter should include your name or investing entity (as the account holder), as well as the balance of cash in the account as of a specific date. It should be on a letterhead from your financial institution and signed by an official representative of that institution.
In practice, a proof of funds letter could be requested by either the home's seller, who wants to make sure that there's a high probability of the sale going through before removing the home from the market, or your lender, who wants to know you'll have enough money to bring to the closing table to cover your down payment and any closing costs or prepaid expenses you'll be responsible for. So it's a good idea to have a proof of funds letter or other sufficient documentation available before you start to submit any offers on properties.
Why is it important to have a proof of funds letter?
While any buyer might be asked for a proof of funds letter by a seller, a proof of funds letter is especially important if you're making an all-cash offer on a property.
In many cases, if a mortgage company has pre-approved you for a loan, the preapproval letter you receive is sufficient documentation to submit to a seller along with your offer. As a personal example: I've purchased two investment properties over the past year -- one was a triplex financed with a mortgage with a 20% down payment, and the other was a single-family home purchased out of foreclosure for cash.
In the case of the triplex, I submitted my mortgage preapproval, and a proof of funds letter was never even requested by the seller (although my lender certainly checked my bank account to verify that I had funds to close). On the other hand, the real estate broker I dealt with in the case of the cash purchase wanted a proof of funds letter before the contract could be signed.
Is a preapproval letter a sufficient proof of funds to close?
If you're buying a property with a mortgage, you probably got preapproved for a loan before you started submitting offers. If you're going to be financing the property -- and want a financing contingency in the contract -- it is standard practice to submit a mortgage preapproval letter along with your offer to show the seller that unless something goes wrong, financing the property shouldn't be an issue.
Having said that, it's important to realize that a preapproval letter and a proof of funds letter are two different things. Specifically, a preapproval letter shows that a lender is willing to provide a loan in a certain amount. It does not tell a seller that you have enough money for the down payment or any other closing costs you might have to pay. If a seller wants assurance that you'll have enough money to close on the property, they may request a proof of funds letter, even if you're using a mortgage to finance the purchase.
What "funds" can you use to close?
Typically, a proof of funds letter is expected to show cash and/or other easily-liquidated assets that don't fluctuate much in value. So things like money market accounts count. You can also potentially use your borrowing capacity under an open line of credit as funds available to close. If your closing funds are coming from more than one account, it's acceptable in most cases to provide more than one proof of funds letter.
On the other hand, investments generally cannot be used for proof of funds. When you're applying for a mortgage, you may be able to use your investment account balances as a source of cash to close or to show that you have adequate reserves. However, a proof of funds letter needs to show a cash balance (but it could potentially be a cash balance in a brokerage account).
How to get a proof of funds letter?
To be perfectly clear, a proof of funds letter doesn't necessarily need to be a letter at all. If you're comfortable providing it, and the seller is comfortable accepting it, a bank statement or brokerage account statement showing a balance sufficient to close on the property is completely acceptable proof-of-funds documentation. You can black out any sensitive information on the statement, such as your account number or Social Security number, in order to protect your privacy.
On the other hand, many people aren't comfortable showing their bank statements to strangers, and that's where a proof of funds letter comes in.
You can request a proof of funds letter from your bank where you hold your account, which should be a quick two to three sentence document that simply states that you had X balance as of X date. Allow a few days for your financial institution to process the document, but in most cases, it's a quick and easy process. Most larger banks handle these types of requests frequently and have their own proof of funds letter templates.
Alternatively, if you're applying for the mortgage and you have already provided your bank statements to your lender, they should also be able to provide a proof of funds letter on your behalf.
The Millionacres bottom line
A proof of funds letter is part of the typical documentation needed to complete a real estate transaction, especially if you're buying a property in cash or are expecting to make a large down payment as many investors do. It's a smart idea to be prepared to provide a proof of funds letter before you start shopping for properties so you'll have it to submit along with any offers you decide to make.