Cash Reserves and Why Lenders Require Them in Your Mortgage

Of all of the underwriting requirements for a mortgage, it’s a good bet you’ve never heard of the term cash reserves. But this is a common lender requirement, that many would-be homeowners don’t learn about until they make an application for a mortgage.

The complication is that while you are saving up money for the down payment on a house, plus any required closing costs, the cash reserve requirement could end up increasing the amount of money that you need to come up with.

Typical cash reserve requirements

The actual cash reserve requirement varies based on the loan type.

Typical cash reserve requirements look like this:

Conventional loans:

Conventional loan reserves are determined by an automated underwriting system, but here are general guidelines.

• Owner-occupied primary residence: typically 0-2 months
• Owner-occupied primary residence, 2-4 family homes: may require additional reserves
• Vacation homes: two months cash reserves, though they can go up to 12 months based on your credit profile
• Investment properties: six months, but can be higher based on your credit profile

FHA loans

• None required unless needed as a compensating factor

VA loans

• None required unless using a jumbo VA loan or buying a multi-unit property

USDA loans

• None required, but can help you obtain an approval.
• If you have more than 20% of the home’s purchase price in reserves, you may be ineligible for a USDA loan

In all cases, some cash reserves are not a bad thing and can help you get approved.

Cash reserves for multiple properties

If you own additional financed properties, the lender will also require additional reserves.

Reserve requirements are:

• 1-4 financed properties: 2% of all unpaid loan balances
• 5-6 financed properties: 4% of all unpaid loan balances
• 7-10 financed properties: 6% of all unpaid loan balances

The home being purchased or refinanced and the borrower’s primary residence is not included in the above.

Someone purchasing an investment property who has five other financed properties would pay 4% of all loans on those properties. So a total debt load of $800,000 across all five properties would require $32,000 in reserves after the down payment and closing costs.

Explanation of cash reserves

Cash reserves are funds left over in your checking, savings, or investment accounts after paying the down payment and closing costs on a home.

When a lender approves your mortgage, they want you to be able to afford to keep the home and make the payments. So they require you to have extra money available after you close on the new loan. This is where cash reserves come into the picture.

Cash reserves are typically expressed in a certain number of months of your house payment. Your house payment has three major components:

• Principal and Interest on the loan itself commonly referred to as “P&I.”
• Taxes, as in the monthly allocation of your real estate taxes
• Insurance, which is represented by the monthly allocation of your homeowner’s insurance, private mortgage insurance (if required), and other types of housing-related insurance, such as flood insurance or earthquake insurance

Together, these three components represent your “PITI,” or Principal, Interest, Taxes and Insurance.

The cash reserve requirement will be based on a certain number of months of PITI. So for example, if your monthly PITI is $1,500, and the cash reserve requirement is “two months,” then you will be required to document that you will have at least $3,000 in liquid assets remaining after the closing to cover the reserve requirement.

Why lenders require cash reserves

No one benefits when a homebuyer can’t make payments.

The bank doesn’t want to foreclose on your home. Banks hate foreclosing, contrary to popular belief. They want you to make your payment.

Since new homeowners are typically most vulnerable in the months following the closing, the availability of liquid cash reduces the likelihood of a missed payment, that could spiral into foreclosure.

So, are cash reserves another homebuying cost?

No. Cash reserves are liquid assets that belong to you. They are not an extra charge or even an escrow that is held by the lender. You merely need to show that they exist before closing. What you do with that money afterward is completely up to you.

How to document cash reserves

You will document cash reserves with two months of bank and investment statements, just like you verify down payment funds.

Acceptable sources of cash reserves include:

• Checking and savings accounts
• Investments, such as stocks, bonds, mutual funds, certificates of deposit, money market funds, and trust accounts (70% of the value is counted)
• The vested balance in your retirement savings (70% of the value is counted)
• The cash value of a life insurance policy

Conversely, some of the sources of cash reserves that are considered to be unacceptable include:

• Funds that are not vested
• Funds that cannot be withdrawn under circumstances other than the account owner’s retirement, termination of employment, or death
• Stocks held in an unlisted corporation
• Non-vested stock options and non-vested restricted stock
• Personal unsecured loans
• Contributions from real estate agents, mortgage brokers, builders, attorneys, or the sellers of the property that you are purchasing
• Cash proceeds from a cash refinance transaction on the property that you are financing

Basically, cash reserves must be your own money and not restricted in any way. That will make them available to meet contingencies after the closing on your loan.

Having cash reserves is in your best interests

One of the riskiest moves that you can make is to close on a large loan obligation without having any liquid cash available after the fact.

You might find yourself cash-short in any given month after the closing. And, purchasing a new home almost always carries the prospect of unexpected expenses.

So if you run into a lender requirement for cash reserves, don’t fight it – embrace it! It really is for your own good.