Why do deposits need to be sourced?

Today’s question is quick: “Why do deposits need to be sourced?”

I presume this question refers to the source of the downpayment for the purchase of a property. When you buy with a conventional loan (e.g. not an FHA loan), the bank lending you the money will very often want to know the source of the funds you are using for the downpayment.

Why? Remember that one of the ways banks think about risk in terms of the relationship between the value of the loan and the value of the property. They want to loan less than the full value of the property, mostly so that there is a cushion in case they have to take a property back. If they loaned $750k against a $1MM property, the thinking is that, even if you default and they have to foreclose, they just bought a $1MM property for $750k.

But there’s another reason banks like to keep the loan-to-value ratio (LTV) low. The lower the LTV, the more cash you, the buyer have to come up with. The more cash you have in the property, the more “skin” you have in the game. You’re much less likely to walk away from a deal into which you’ve poured your savings.

And now we come to the major reason for “sourcing”. If you got the funds to do the deal from someone else, either as a gift or a loan, walking away might mean a lot less to you than if it’s your own money. So, in order to protect their capital, banks try to make sure that the downpayment is, in fact, yours.