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Why Mortgage Reserves Matter When Buying a Home

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There’s a lot of money involved in buying a home. Not only do you have to save for a down payment and closing costs, but in many cases, you may need several months’ worth of mortgage reserves set aside in cash. Lenders want to know you can maintain your payments if you face a job loss or reduction in income.

What are mortgage reserves?

Mortgage reserves — also called cash reserves — are funds that are accessible to a borrower after they’ve paid their down payment and closing costs. The funds must be liquid or near liquid, meaning they can be quickly turned into cash.

Reserves are meant to cover several monthly mortgage payments in the event of a financial emergency, and are calculated by how many payments you can make with the amount of money you have saved. The monthly payments must include PITI — principal, interest, property taxes and homeowners and/or mortgage insurance — as well as any applicable homeowners association dues, leasehold payments and secondary financing payments.

Why mortgage reserves matter

Cash reserves are important to the homebuying process for several reasons, said Barry Zigas, a senior fellow and former director of housing policy at the Consumer Federation of America in Washington, D.C.

For one, when you buy a home, you’re taking on a large, recurring expense in the form of a monthly mortgage payment.

“You can rest easier as a buyer if you have a comfortable cash cushion, so that if you have an interruption in income of any kind or an unexpected reduction in hours, you’ll have some reserves upon which you can draw,” Zigas said.

There are also overlooked expenses that arise when you own a home, such as buying additional furniture and paying for maintenance. Having reserves at the ready will make it easier to cover those costs.

Mortgage lenders also care about reserves for obvious reasons — they want to minimize their own risk.

“It’s a sign of resiliency on the part of the borrower,” Zigas said. “In other words, they would have the ability to weather interruptions and that’s an important compensating factor for other factors in the underwriting.”

Which funds meet mortgage reserve requirements?

The following assets meet cash reserve requirements, according to Fannie Mae guidelines:

  • Cash
  • Funds in a checking or savings account
  • Funds in a trust account
  • Investments in bonds, certificates of deposit, money market funds, mutual funds or stocks
  • Vested amount in a retirement savings account
  • Cash value of a vested life insurance policy

The funds listed below don’t meet mortgage reserve requirements:

  • Unvested funds
  • Funds that can’t be withdrawn outside of retirement, employment termination or death
  • Stocks held in an unlisted corporation
  • Unvested restricted stock and stock options
  • Unsecured personal loan proceeds
  • Funds from someone who benefits from the home purchase
  • Funds from a lender
  • Cash-out refinance proceeds (from a refi on the property being financed)

What is the reserve requirement for my mortgage?

Here’s a breakdown of mortgage reserve requirements for purchase transactions, by loan type:

Loan type Cash reserve minimum
Conventional loan Up to six months, depending on credit score, debt-to-income (DTI) ratio, loan-to-value (LTV) ratio and number of units
FHA loan One month for one- to two-unit properties; three months for properties with three or four units
VA loan Up to six months, depending on number of units
USDA loan Not required

Cash reserves for investment properties

If you’re buying an investment property, your lender will need proof that you have plenty of reserves on standby in the event your rental income dries up.

You’re required to have at least six months’ worth of mortgage reserves saved when you apply for an investment property loan. The goal: to demonstrate your ability to withstand a rainy day as a landlord.

4 ways to boost your mortgage reserves

You shouldn’t completely drain your savings to buy a home. There are many expenses left to consider once you leave the closing table and receive your keys.

That’s why it’s critical to have a healthy emergency savings fund. Failing to plan ahead and save could leave you facing financial turmoil.

Consider these four ways to pad your cash reserves:

Automate your savings schedule. Have a set amount of your earnings direct-deposited into your savings account on each payday, or set up an automatic recurring deposit from your checking to your savings account through your bank or credit union.

Reduce your expenses. Revisit your most recent bank statements and look for ways to trim your spending. Cancel subscriptions for any items you no longer use (like monthly subscription services or a top-tier cable plan), and scale back on dining out and impulse shopping.

Pick up a side hustle. If you earn more, you’ll be able to save more. Consider starting a side hustle, such as freelance writing or tutoring, to supplement your current income and make room for additional savings.

Remember your windfalls. Each time you get a bonus from your employer, an income tax refund or some other financial windfall, divert some or all of those funds to your savings account.

 

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