Mortgage Reserves

What Assets Does a Home Buyer Need?

Two people looking at a computer surrounded  by moving boxes.

Getting ready to buy a home? If you’re a saver, you have a head start. When a lender sizes up your buying power, one big question is how much savings you will have in reserve.

Beyond your down payment and your closing costs, you should set aside several months’ worth of cash for future loan payments. That’s what mortgage reserves are ready assets at your disposal after you buy a house.

With mortgage reserves, if you bump into unforeseen financial setbacks, a lender can still assume you’ll be able to cover your mortgage payments. But cash reserves do more than help a buyer qualify for loans. Owners with healthy cash reserves set themselves up for satisfaction and comfort with their decision to own a home.

Before the Reserve: Down Payment and Closing Costs

The price of the house you’ll buy is one key factor in your closing budget, of course. Yet there’s more to the equation. Closing costs will include taxes, plus an array of intermediaries’ fees. These costs typically add up to around 5% of the amount of the home buyer’s mortgage.

How much will you have for a down payment? Wondering how much is best to put down? Check the guidance from the Consumer Finance Protection Bureau. As a rule, a 20% down payment is rewarded with the best mortgage payment terms and interest rates. Plus, it avoids the extra monthly cost of private mortgage insurance (PMI). Lenders require PMI insurance when a buyer is not yet invested at that 20% level.

Pro tip: Like other mortgage insurance policies, PMI protects the bank. It lowers the lender’s risk in case of a borrower default. As a borrower, you receive no benefits for paying the monthly PMI charge on behalf of your lender. As a homeowner, you’ll want to shake it off as soon as possible! After you attain 20% home equity, you can request the removal of PMI from your conventional loan. If you have an FHA loan, you can refinance to a conventional loan at that stage — without the PMI.

Now, lets’ talk mortgage reserves.

Why You Need Reserves: Loan Principal, Interest, Taxes, and Insurance

Mortgage lenders ask applicants (typically more than once!) for their most recent two months of bank account statements. One reason is to ascertain whether the applicant can reserve at least two months of house payments after the purchase. Conventional loans can require two to six months of reserves. It depends on the borrower’s overall credit and income profile, the loan amount, the type of property purchased and its value. In some cases, you need even bigger reserves — for example, if you’re buying an investment property.

What precisely should reserve funds be able to cover for the specified number of months? The loan principal and interest. Real estate taxes. Any secondary financing. Homeowners’ association dues if you’re buying into a multi-unit property (but not utility bills). Property hazard insurance costs. And also, where applicable, mortgage insurance premiums or leasehold payments.

Each set of circumstances is different. Some family contributions count as reserves; some don’t. There are many questions to answer and documents to send, showing how the assets are sourced and held. Your mortgage professional can tell you whether the lender will require a reserve, how much it will be if so, and what documents need to be sent. Fortunately, most everything can be sent electronically these days!

Qualifying Sources of Cash Reserves

Loan applicants can show a number of asset types to help in the approval process. Non-cash assets that can be sold quickly are, like cash, deemed liquid reserves. Mortgage reserve funds need to be in liquid form or able to be tapped and converted should the need arise.

With this in mind, consider some examples of acceptable reserve assets.

Acceptable assets for a lender’s reserve requirements

If reserves are required, retrieve your proof of holding the assets. If you have an account with stocks and bonds, it can make sense to move some into cash as necessary (or request your dedicated fund adviser to do this). Other liquid or near-liquid assets for a home buyer’s cash reserves include:  

  • Regular income.
  • Disaster relief funds, lottery winnings, or court settlements (if their source doesn’t benefit from the mortgage or the real estate transaction).
  • Cash in checking or savings and trust accounts with a bank or credit union.
  • Vested amounts in employee 401k accounts.
  • Retirement accounts such as IRAs and Roths.
  • Vested cash value from life insurance.
  • CDs, short-term treasury bills, money market accounts and mutual funds.

Assets that don’t count for reserve requirements

Just to be clear, these types of assets will not count as cash reserves:

  • Cash-out refinance loans secured by the same home.
  • Unvested funds and money that’s unavailable except through a major life change.
  • Investments in private companies and unvested stock options.
  • Proceeds from unsecured personal loans or student loans.

Sources: LendingTree; Fannie Mae Selling Guide; Freddie Mac Seller/Servicing Guide: Asset Eligibility and Documentation Requirements.

Other Sources of Cash

Are you dipping into your retirement funds before age 59½? Then be prepared for the early withdrawal fee. What’s more, the IRS treats the withdrawal as income. You could be moving yourself to a higher income tier and have to cover extra income taxes next year. Remember: When your income goes up, income-based federal benefits such as Affordable Healthcare Act funds need to be reimbursed (to the extent you didn’t estimate your “income” as supplemented by early retirement withdrawals).

Even though you’ll want to include windfalls, loan underwriters are leery of unexpected cash infusions and major financial changes. They prefer repetitive, reliable sources of income. Is anything happening in your life to change your income? Be sure your mortgage specialist knows what’s coming and can speak with the underwriter about it. Using a gift? Find out if it’s acceptable to your lender. Because giving is a one-time event, it is not considered an example of stable income.

Pro tip: If a gift will comprise part of your house payment or cash reserves, find out early on if you need a gift letter. This document names the source of the gift, stating that the money is a gift, not subject to repayment. 

Why Cash Reserves Ultimately Matter to the Buyer

No matter what the lender may or may not require, homeowners should hold at least three to six months of home and mortgage expenses, just in case of an emergency. In addition, home buyers must plan for the costs of home maintenance. A big house, or one that needs work, places heavy demands on its owner’s savings.

For the above-mentioned reasons, it’s best to keep housing costs under 25% of monthly earnings if possible. And sufficient reserves should always be available in bank accounts, or at least accessible from stable, low-risk investments.

All of that said, there has to be a balance. Insufficient cash may lead to unmanageable debt. Yet cash hoarding can mean missed financial opportunities. The happiest homeowners find more opportunities to create, invest, and grow.

“Happiness is a risk,” wrote Sarah Addison Allen. “If you’re not a little scared, then you’re not doing it right.”

Supporting References

Freddie Mac Seller/Servicer Guide (2021). Section 5501.2: Calculation of Reserves; Section 5501.3: Asset Eligibility and Documentation Requirements.

Fannie Mae Selling Guide (2021). Home Buying – Mortgage Reserves and Assets Needed to Buy a Home (undated).

Photo credits: Ketut Subiyanto via Pexels.