When buying a home, just how much do you need? Believe it or not, it’s actually more than the listing price or the offer you are about to make. Before you fall in love with a home, be sure you understand exactly what it takes — financially speaking — to call it your own.
Most of us know buying a home requires a down payment. The percentage you put down can vary by loan program, but it can be as little as 3% or as high as 20%. Then there are closing costs, which include third-party fees, appraisal fees, taxes, etc. Those usually average around 3-5% of your loan amount.
That’s not it, though. Don’t forget the not-always-top-of-mind mortgage reserves, which are reviewed during the underwriting process. To ensure you’re more than prepared during the mortgage application process, let’s go over the specifics and requirements of mortgage reserves.
What are mortgage reserves?
Reserves are savings balances that will be there after you close on your home purchase. They’re considered emergency funds, meaning if you lose your job after your home purchase, you are still able to afford your mortgage.
How does a mortgage reserve work?
Say your lender requires at least two months of mortgage reserves after closing. If you're unable to show proof of these funds (known as PITI, which we'll discuss later in the article), you may not be able to move forward with your application. That's why it's important to have liquid reserves at this time.
Keep in mind that while some lenders may require just a few months of mortgage reserves, others ask borrowers to provide a year's worth of such funds. So what qualifies as an acceptable source of liquid reserves? Take a look.
Liquid reserves
Cash and other assets that are easily converted to cash are called liquid reserves. Acceptable sources include:
Checking or savings accounts
Stock or bond investments
Certificates of deposit (CDs)
Trust accounts
Money that is vested in a 401k, IRA, or other retirement savings account
The cash value of a vested life insurance policy
Seasoning and sourcing your assets
Banks and mortgage lenders will ask for two months’ worth of bank statements during the loan process. Therefore, it’s important your assets are seasoned and sourced. Here’s what they mean.
What are the benefits of buying a home with cash?
Seasoned assets
Think paychecks or deposited money that you rely on day in and day out. You need to keep a healthy balance, especially as you’re 60 days out from a mortgage application. Don’t go spending more money than usual. Your lender is going to want to see you can cover a down payment, closing costs, and the reserves needed in the event you lose your job after the mortgage closes. Don’t make a random, large deposit either. It may be concerning to your underwriter and could result in you providing a letter of explanation. Can’t provide one? Then you could be looking at mortgage denial.
Plan to receive gift money to help with a down payment? Be sure to follow these steps first.
Sourced assets
If you receive any gift money, be sure you have the proper documentation to show for it. The lender needs to be sure you’re not taking on any additional debt when receiving those funds, meaning you’re not borrowing that money from a personal loan or from the bank of Mom and Dad. They also want to verify you have an established savings pattern and that you’re good with managing money (and ultimately repaying large debts).
Learn: What is a Pledged Asset Mortgage?
Cash reserves
The term cash reserves define a certain number of months of your house payment, which is comprised of three components: , also known as PITI. If your lender requires two months’ of PITI in your cash reserves, and your loan’s PITI is $2,000, you’ll need $4,000 in liquid assets after closing your mortgage. If you do not have at least that amount, you will not receive mortgage approval.
Why does it matter? Again, if you were to lose your job at any point after receiving a mortgage loan, the lender wants to feel confident you can continue making payments. They don’t want you to end up in mortgage default.
Tip: after your loan closes, it’s best practice to keep four to six months’ worth of housing expenses in your savings as reserves.
Asset reserve requirements for a mortgage
Requirements vary based on lender and loan program. Though credit score, loan to value (LTV), and property type also come into play when you’re applying for a conforming (non-Jumbo) loan, like those backed by Fannie Mae and Freddie Mac.
Reserves by property type
Owner-occupied residences typically require two months in reserves, but a lender may ask for up to six months.
A second home or vacation home purchase may require anywhere from two to four months of reserves but, again, it can be higher.
Investment properties often require the most reserves, anywhere from six months or higher pending your credit profile and lender guidelines.
Reserves by loan program
FHA loans that fund one to two-unit properties usually do not require mortgage reserves. Though reserves are necessary if you finance a three- or four-unit property using an FHA loan. Check with your lender to know if its rules differ.
USDA loans do not require reserves on any size property.
VA loans are similar to the FHA loan rule. There isn’t a reserve requirement unless you are funding a three- or four-unit property and you’re using rental income to qualify.
Conventional loans may require zero or up to six month’s reserves depending on your debt-to-income (DTI) ratio, credit score, LTV, etc.
Jumbo loans, again are not conforming, have their own set of rules though you should expect to provide anywhere from three to six months’ worth of reserves.
The bottom line
As you plan to purchase a home, be sure to consider mortgage reserves in your budgeting. An easy way to research how much you may need is by trying a mortgage calculator. You can estimate your monthly mortgage payment based on your anticipated home price, loan term, and interest rate. Once you have that monthly payment, multiply it by two to get your minimum mortgage reserves.
Better yet, make a call to a mortgage professional. When you choose to work with a dedicated mortgage consultant, you’ll receive guidance without any pressure. Get your questions answered today by calling (800) 910-4055, and be another step forward along the path to homeownership. We’re even available nights and weekends.
Learn: Budgeting for a new home with one income.
