Cash reserves are monies that you need to show a mortgage lender that you have leftover after settlement for emergency and for cash cushion, to convince the lender you have some reserves after settlement in case of any issues when transitioning into a new mortgage loan. Obviously underwriting guidelines can change based on loan type and circumstances, and sometimes the rule makers simply change the rules. So it is always important to ask a lender what the rules are in your specific timeframe and for your specific scenario. Below are general guidelines for cash reserves.
For Fannie Mae and Freddie Mac loans, which are rules for Conventional Conforming loans, reserve requirements vary based on credit score and loan-to-value (LTV), along with property type. They can range from as little as zero months of your mortgage payment to as much as 12 months, depending on the scenario and amount of equity in the home. And the mortgage payment should be defined as the total payment including property taxes, homeowners insurance, any mortgage insurance, any homeowners association fees, etc.
The automated underwriting decision will determine the needed reserves.
Borrower(s) must have 2 months of the mortgage payment for the new loan in reserves. In addition, Borrower(s) must have an additional 2 months mortgage payment in reserves for each other financed primary residence, second home and/or 1-4 unit Investment property in which the Borrower(s) have an ownership interest OR on which the Borrower is obligated.
Investment property (subject property):
Borrower(s) must have 6 months of principal, interest, taxes, and insurance (PITI) in reserves regardless of whether rental income is used to qualify the borrower(s). In addition, Borrower(s) must have additional 6 months PITI in reserves for each other financed primary residence, second home and 1-4 unit Investment Property in which the Borrower(s) have an ownership interest OR on which the Borrower is obligated.
Borrower’s current primary residence is pending sale or being converted to a second home or investment property: Borrower(s) must have 6 months PITI in reserves for the new Primary residence and 6 months PITI in reserves for the current Primary residence pending sale/being converted. The required reserves can be reduced to 2 months PITI in reserves for each of the new primary residence and current Primary residence pending sale / being converted if all of the following requirements are met:
- Value of property pending sale / being converted is supported by a new appraisal with at least an exterior-only inspection and is no more than 60 days old.
- LTV/TLTV for pending sales being converted to a rental property is less than or equal to 70%.
For jumbo loans, reserve requirements can vary tremendously, from as little as six months to several years, depending on how large the loan is. It could even be a percentage of the purchase price of the new property, for example 10% of the sales price. A common cash reserve requirement for a jumbo loan is 12 months of your monthly mortgage payment, six of them being in liquid cash in accounts such as checking, savings, and money market accounts; and another six months in illiquid accounts such as retirement accounts. If you are doing a jumbo loan you need to specifically ask your lender how much reserve requirements are being required of you in your scenario.
When you own other rental properties but are buying a primary residence using a new FHA loan, there are no reserves needed for the other existing investment properties.
There is no reserve requirement for FHA loans on 1-2 unit properties. However, 3-4 unit properties typically require three months of PITI.
For VA loans, there isn’t a reserve requirement unless it’s a 3-4 unit property, at which point six months reserves are required. For VA 1-2 unit properties, VA does not require the applicant to have additional cash to cover a certain number of mortgage payments, unplanned expenses, or other contingencies. However, the applicant’s ability to accumulate liquid assets and the current availability of liquid assets for unplanned expenses will be considered in the overall underwriting, but there is no written requirement.
And if it’s a Jumbo VA loan being applied for, which are all VA loans over $417,001, then at least 2 months of cash reserves are required. Additionally if the veteran owns other property, three months of reserves are required for each rental property owned that is not secured by a VA loan.
ALLOWABLE TYPES OF ASSETS FOR CASH RESERVES:
- Checking Account/Saving Account/CDs/Money Market Account.
- Business accounts (with a letter written by the business’s accountant saying that a withdrawal from this account should not harm the operation of the business).
- IRA/401(k) Accounts (60% counted towards requirement)
IRA/401(k) and other retirement accounts:
Because a 401(k) account is your personal investment, most lenders will allow you to use these assets as proof of reserves. However, your lender will likely only count 60% of your account funds, due to the taxes and penalties you will pay if you actually have to withdraw the money early to cover your mortgage payments. Using your 401(k) investment as your reserves does not require you to actually make a withdrawal; your lender simply wants to see that it’s there and available, so you’ll be required to furnish current account statements. And you will need to provide documentation on what the terms of withdrawal are to make sure you can get to the money if it were needed in an emergency.