Last week’s article touched on the subject of prequalifying for a mortgage and, although reserves were mentioned, there is much to know about reserves, their requirements, and what they can do for you on your home buying journey. Because understanding reserves is so important, I feel that they deserve to be expanded upon in more detail.
What are reserves?
Mortgage reserves can be described as a sort of savings reservoir to cover mortgage payments after closing on a home. These savings will aid the borrower in case of a catastrophic event hindering their ability to pay their monthly mortgage normally, such as sudden unemployment.
Therefore, setting aside reserves will put lenders more at ease with accepting a potential borrower, as it exists as a safety measure to prevent lapse in payment. It is recommend to save 4-6 months worth of reserves after closing, just to be safe.
These savings can be accumulated from multiple sources, separated into the following categories: seasoned assets, liquid reserves, cash, and sourced assets.
Seasoned assets are essentially your paychecks, or your regularly deposited cash-flow. Be aware that when filling out a mortgage application, your spending habits prior to the application will be taken into account.
Avoid spending significantly more than you normally would, as this could be interpreted as a red flag to the lender and hurt your chances of acceptance. Additionally, any large deposits could be worrisome to lenders as well, so be ready to support any deposits such as these with proper reasoning and documentation, such as any large bonuses that come your way.
Liquid reserves include:
- Bank accounts
- CDs (Certificates of deposit)
- Stocks or bonds
- Life insurance (cash value)
- Trust accounts
- Retirement accounts (IRAs, 401ks, etc.)
Cash reserves are measured in months of house payment as your PITI, or your principal & interest, taxes, and insurance. Lenders may require a specified amount of months worth of PITI in cash reserves.
Sourced assets include any gift money you have received from outside sources, that will require documentation on your end. Any gift money you have received in the form of additional debts, such as loans from friends or relatives, will reflect poorly on the borrower as it could indicate to the lender that the borrower’s ability to manage funding needs improvement.
What are the requirements?
Lenders will generally require a certain months’ amount in reserves. Different types of properties will require different amounts in reserves. Per property type, you may see these requirements:
Owner-occupied homes: 2-6 months
Investment homes: 6 or more
Vacation or secondary homes: 2-4
Note that these requirements could be higher depending on the lender, as all of them will have different reserve requirements.
How is credit taken into account?
It goes without saying that we all benefit from having a high credit score for a multitude of reasons, and settings aside reserves is no exception. A higher credit score could mean less required of you for reserves, which means more money you get to keep in your pocket upon closing! So be sure to monitor your score well going in.
I hope this article has helped you understand reserves a bit better, and helps pave the way for success during your home search. As always, I’m here for you and can be contacted at 480-355-8645 if you have any other questions or want to discuss your plans for setting aside reserves.