What are reserves in mortgage?
Are you in the process of purchasing a house or you want to purchase a house but you’ve been told you need reserves? While many first-time home buyers are aware of their need for a down payment and even closing costs, you may not be aware of reserves.
You may need mortgage cash reserves if you have less than perfect credit, need help to strengthen your application, or want to purchase an investment property.
What are mortgage reserves?
Mortgage reserves are simply extra cushion you have available after you cover the down payment and closing cost on your house. They are emergency funds that show the lender you have the ability to make the payment in the event of a financial emergency.
How do mortgage reserves work?
Mortgage reserves are one month of your total mortgage payment. Your mortgage payment is known as PITI (principal, interest, taxes, and insurance).
Let’s say your monthly payment breaks down as follows:
- Principal & Interest: $900
- Property Taxes: $200
- Insurance : $200
- PMI: $150
Your total mortgage payment would be $1450 per month. So one month of mortgage reserves would be $1450.
How many months you will need to have saved up will depend on:
- Your personal credit profile
- The lender you are working with
- The loan program you are using
If you are buying a primary residence, you could be required to have between one and three months of mortgage reserves. That’s one to three months of mortgage payments saved AFTER you cover your closing costs and down payment.
When are mortgage reserves required?
Mortgage reserves are going to be required if you have to have your loan manually underwritten or if you are purchasing an investment property.
Some lenders may have an overlay that requires you to have reserves regardless of manual or automated approval. This is one reason why it can be better to work with mortgage brokers who don’t have overlays with many of their lenders.
What can be used as mortgage reserves?
In order for the money you have saved to be used as mortgage reserves, it has to meet the same criteria as your down payment and closing costs.
Most importantly your mortgage reserves cannot be cash. Just like your down payment and closing costs funds they must be sourced.
What are sourced funds?
Sourced funds are basically funds with a paper trail. The lender who is underwriting your loan must document that:
- You did not borrow the funds and take on new debt
- The funds weren’t obtained from illegal measures
- You have a consistent pattern of saving
Types of Sourced Funds:
- Checking and Savings Accounts
- Certificate of Deposit (CD’s)
- Vested Retirement Funds (401k’s 402b’s and IRA’s)
- Cash Value Life Insurance Policy
- Stocks or Bonds
- Trust Accounts
Can mortgage reserves be a gift?
Gift funds are not allowed for use as mortgage reserves. If you have to provide reserves for your loan approval, the money will need to be from your own funds.
If you are receiving a gift from a family member those funds could be used to cover your down payment and/or closing costs.
Funds Must Be Seasoned
All funds used during the mortgage process must be seasoned. This includes gift funds, down payment funds, and closing cost funds.
What Are Seasoned Funds?
Seasoned funds are funds that have been in your account for at least 60 days before your mortgage application. You’ll be required to provide the most recent 60 days of your account statements to prove your funds are seasoned.
Any large deposits (typically over $500) will be required to be sourced. If you cannot provide an acceptable source for those funds they will not be accepted.
Mortgage Reserves by Property Type
When buying a primary residence you typically won’t be required to provide mortgage reserves unless your lender has an overlay or you need to do a manual underwrite.
If you have to do a manual underwrite you’ll need to provide between one to three months of mortgage reserves.
When buying a vacation home, you’ll need to have document reserves not just for your vacation property but also for your primary residence.
The amount of reserves needed is usually between four to six months of mortgage payments saved.
Investment properties have the most reserve requirements of any property type. Like vacation homes, you’ll need to provide mortgage reserves for each investment property you own.
Why are mortgage reserves important?
Reserves are important because they are there to protect you and the lender in the event of a financial emergency.
If you were to be unable to work due to job loss, sickness, or another emergency, reserves will help you make your mortgage payment.
Buying a home will make a large financial impact on your current savings and your monthly spending. There will be new expenses you may not have had before such as:
- Home maintenance
- Home repairs
- HOA fees
Having a little cushion saved up will help you prevent being “house poor” and not having the funds needed to cover your bills.
Planning Your Budget
Property planning to buy a house should include setting a home buying budget. You should never rely on a mortgage lender to tell you how much you can spend each month.
While you won’t be able to spend more than a mortgage lender approves you for, if you have very little debt or a high income, you may qualify to purchase a home that’s much more expensive than you want to spend.
A good rule to follow is to budget between 25 and 30 percent of your monthly take home pay toward your mortgage payment.
Mortgage Reserves FAQ’s
What is manual underwriting?
Manual underwriting is the process of having an underwriter manually review your loan application. Unlike an automated approval, a manual underwrite is up to the underwriter to approve.
You’ll be required to provide more documents and go through a more thorough process. Many lenders won’t even offer manual underwriting but it’s a great tool to help potential homebuyers who may not qualify for other options.
What are Cash Reserves?
This can be a bit of a misleading definition of reserves. You may hear this term, but after reading this you know that cash is not an acceptable format to prove reserves.
Cash reserves is simply referring to mortgage reserves. We prefer this term because it’s not misleading about where your funds should come from.
Should I plan to have mortgage reserves?
If you have a low credit score, have many disputes on your credit report, have filed for bankruptcy, or had a foreclosure you should certainly expect to need reserves.
The best way to learn about what you’ll need to get a mortgage approval is to speak to a loan expert.
Does the lender take my reserves at closing?
No. Mortgage reserves are not money the lender collects from you. When you show the loan officer or lender you have reserves you are simply documenting that you have an emergency fund. You keep that money and only pay your down payment and closing costs at closing.