Why Mortgage Reserves Matter When Buying a Home
WHAT YOU'LL LEARN
What a mortgage reserve is
When they’re required
How to improve them
WHAT YOU'LL LEARN
What a mortgage reserve is
When they’re required
How to improve them
Setting aside cash for your down payment and closing costs is one of the earliest steps in the homebuying process. But aside from those two big-time expenses, you may also need to consider what’s known as “mortgage reserves.” For some loan scenarios, lenders want to see diverse revenue streams – like a well-kept savings account or other types of assets you can use to cover your mortgage should significant or unexpected changes occur to your income (we’re speaking from experience here). Enter stage left, mortgage reserves...
What Are Mortgage Reserves?
Mortgage reserves, also known as cash reserves or emergency funds, are assets that can quickly convert to ready cash after closing if you need help covering your mortgage payment. They grant lenders peace of mind, knowing you can afford your loan should you suffer a major loss of income or unemployment. Generally speaking, these reserves are the funds you still have available after covering your down payment and closing costs.
Expert Tip
Think of mortgage reserves as a separate savings account – cash funds readily available when you need it most!
Sometimes required on both purchase and refinance loans, mortgage reserves are measured in months. Don’t worry, we’ll elaborate. If you have, say, $6,000 left over after purchasing your home, and your principal, interest, taxes, and insurance (PITI) come out to around $2,000, you have three months' worth of mortgage reserves to start. The more months you have in the “bank” to start, the better you’ll be off if the unexpected rears its ugly head.
Not everyone needs mortgage reserves, but they could come in handy for borrowers with a less-than-ideal credit score or high debt-to-income (DTI) ratioThe percentage of your gross monthly income that is used to pay your monthly debt and determines your borrowing risk.debt-to-income (DTI) ratioThe percentage of your gross monthly income that is used to pay your monthly debt and determines your borrowing risk..
Acceptable Sources of Mortgage Reserves
While not the standard for every lender, Atlantic Bay Mortgage Group® accepts the following sources for mortgage reserves:
Checking or savings accounts
Vested investment stocks, bonds, or certificates of deposits (CDs)
Vested mutual, money market, or trust funds
The amount vested in a retirement savings account
The cash value of a vested life insurance policy
Acceptance of these reserves are at the discretion of the Underwriter based on loan type and risk.
Unacceptable Sources of Mortgage Reserves
Remember, your mortgage reserves are “ready cash,” meaning “money you have now.” So, the following examples CANNOT count as part of an Atlantic Bay Borrower’s mortgage reserves:
Funds that have not been vested
Funds that cannot be withdrawn under circumstances other than the account owner’s:
Retirement
Employment Termination
Death
Stock held in an ineligible corporation
Non-vested stock options
Non-vested restricted stock
Personal unsecured loans
Interested Party Contributions (IPCs)Payment by an “Interested Party,” or combination of parties, toward origination fees, closing costs, or discount points.Interested Party Contributions (IPCs)Payment by an “Interested Party,” or combination of parties, toward origination fees, closing costs, or discount points.
Any amount of Lender Credit
Proceeds from a cash-out refinanceThe option to replace your existing mortgage with a larger loan amount. The difference is paid to you in cash.cash-out refinanceThe option to replace your existing mortgage with a larger loan amount. The difference is paid to you in cash. transaction on the subject property
Remember, the list above does not serve as a standard for all lenders but can be a good rule of thumb to remember when gathering your reserves.
Converting Mortgage Reserves To Cash
When thinking about mortgage reserves, keep this little phrase in the back of your head: lenders love liquidity (we love alliteration, too, but that’s positively pointless). To make mortgage reserves “liquidInvestments easily convertible to cash without incurring penalty.liquidInvestments easily convertible to cash without incurring penalty.,” convert them to cash by:
Drafting or withdrawing funds from an account
Selling an asset
Redeeming vested funds
Obtaining a loan secured by assets from a fund administrator or insurance company
That being said, mortgage reserves are not “solids,” like cars or collectibles.
Expert Tip
Lenders cannot consider your car, second home, or personal valuables as mortgage reserves because they can’t easily convert to cash.
When Are Mortgage Reserves Needed?
Most lenders don’t need mortgage or cash reserves from borrowers unless the loan product or program requires them. Conventional loans backed by Fannie Mae or Freddie Mac can range from zero to six months of cash reserves depending on credit score and a few other factors, while Federal Housing Administration (FHA) loans require at least one month of reserves in most cases and at least three months' worth for 3- or 4-unit properties. Reserves are at the Underwriter’s discretion for Department of Veterans Affairs (VA) loans, and U.S. Department of Agriculture (USDA) loans may not require cash reserves at all.
It’s also important to note that reserve requirements can vary from lender to lender, and some may need reserves if the borrower’s down payment amount, credit score, or DTI ratio does not meet their guidelines. But here’s the good news: you have control over all three of those examples!
Improve your credit score and DTI ratio by paying down outstanding debt.
How Much Do I Need In Mortgage Reserves?
The exact amount you’ll need in mortgage reserves varies, depending on your loan program, credit score, DTI ratio, and even the difference between your loan program and loan-to-value (LTV). Lenders usually want to see at least a few months of mortgage payments in liquid assets, in addition to the down payment and closing costs, before closing. The less ideal your credit score or DTI ratio is, the more reserves a lender may require.
Remember, $6,000 and $2,000 in PITI after closing equals about three months in mortgage reserves.
What If I Don’t Have Enough Mortgage Reserves?
If you don’t have the liquid assets right now to meet lender or loan program reserve requirements, don’t lose hope just yet. Evaluate your credit score and work with a Mortgage Banker to calculate your DTI ratio. The results may surprise you, and you may need fewer reserves than you think. And keep in mind, VA and USDA loans may not require cash reserves at all.
But if you’re concerned about having enough reserves, create a savings plan to build up funds and other qualifications to get that lower reserve amount you’re looking for.
Speaking of...
Boost Your Mortgage Reserves
Mortgage reserves are never set in stone (...until they are), which means you can reduce the amount you’ll need to have by performing a few key actions. Review your budget and see if there are any expenses you can cut out, then redirect those funds to your mortgage reserves. You could also save automatically by setting up automated monthly deposits with your bank. Or maybe, for those fortunate folks out there, take part of your windfall incomeA sudden and substantial monetary gain (i.e., tax returns, inheritance, or lottery).windfall incomeA sudden and substantial monetary gain (i.e., tax returns, inheritance, or lottery). and put it toward your reserves. Just be careful to save enough money for other obligations.
Contact us today for more information about mortgage reserves and for tips on saving for these precautionary payments.
Mortgage reserves, also known as cash reserves, are liquid assets you have available after covering your down payment and closing costs. They represent the funds you could use to continue making mortgage payments if your income were disrupted unexpectedly. Lenders measure reserves in months, based on how many monthly mortgage payments the available assets could cover. For example, if your monthly mortgage payment is $2,000 and you have $6,000 in eligible liquid assets remaining after closing, you have three months of mortgage reserves.
Whether mortgage reserves are required depends on your loan type, credit score, debt-to-income ratio, and down payment amount. Conventional loans backed by Fannie Mae or Freddie Mac may require between zero and six months of reserves depending on those factors. FHA loans typically require at least one month of reserves, and at least three months for three- or four-unit properties. VA loans handle reserves at the underwriter's discretion, and USDA loans may not require cash reserves at all. Some lenders may also require reserves if a borrower's credit score or DTI ratio does not meet standard guidelines, even when the loan program itself does not mandate them.
Acceptable sources of mortgage reserves are liquid assets that can be quickly converted to cash. Atlantic Bay Mortgage Group accepts the following as mortgage reserves: checking or savings accounts, vested investment stocks, bonds, or certificates of deposit, vested mutual funds, money market accounts, or trust funds, the vested amount in a retirement savings account, and the cash value of a vested life insurance policy. Acceptance of these sources is at the underwriter's discretion based on loan type and risk.
Several asset types do not qualify as mortgage reserves because they cannot be quickly converted to cash or are otherwise ineligible. Items that generally cannot count as reserves include unvested funds, funds that can only be withdrawn upon retirement, employment termination, or death, non-vested stock options, non-vested restricted stock, personal unsecured loans, interested party contributions, lender credits, and proceeds from a cash-out refinance on the subject property. Physical assets such as cars, second homes, and personal valuables are also not eligible because they cannot be easily liquidated.
The amount of mortgage reserves required varies based on your loan program, credit score, debt-to-income ratio, and loan-to-value ratio. Lenders typically want to see at least a few months of mortgage payments in liquid assets beyond the down payment and closing costs. The lower your credit score or the higher your DTI ratio, the more reserves a lender may require. If your loan program and financial profile are strong, reserves may not be required at all. Your Mortgage Banker can calculate what you may need based on your specific situation.
If you do not currently have enough liquid assets to meet reserve requirements, there are steps you can take. Improving your credit score and reducing your debt-to-income ratio by paying down existing debt may reduce the amount of reserves a lender requires. VA and USDA loans may not require reserves at all, so exploring those programs may bean option if you are eligible. Building savings through a dedicated plan, automated monthly deposits, or directing windfall income toward your reserves can also help you meet requirements before applying.
For VA loans, reserve requirements are handled at the underwriter's discretion rather than being set as a fixed program requirement. In many cases, VA loans do not require cash reserves, which is one of several financial advantages the VA loan program offers to eligible servicemembers, veterans, and surviving spouses. Atlantic Bay has extensive experience working with military borrowers across Virginia Beach, Hampton Roads, and other military communities and can help eligible borrowers understand how VA loan reserve guidelines apply to their specific situation.
There are several practical ways to build mortgage reserves before closing. Reviewing your budget and reducing discretionary spending can free up funds to direct toward savings. Setting up automatic monthly transfers to a dedicated savings account makes the process consistent without requiring active effort. Directing windfall income such as tax refunds, bonuses, or other one-time payments toward reserves can also accelerate your progress. Improving your credit score and lowering your debt-to-income ratio may reduce the amount of reserves a lender requires, which can make the target easier to reach.