How Financial Reserves Impact Your Mortgage
Background
Liquid reserves are those financial assets that are available to you after your loan closes. Liquid financial reserves include cash and other assets that are easily converted to cash by the borrower.
Examples of liquid financial assets that can be used for reserves include:
- Checking or savings accounts;
- Investments in stocks, bonds, mutual funds, certificates of deposit, money market funds, and trust accounts;
- The amount vested in a retirement savings account; and
- The cash value of a vested life insurance policy.
What You Need to Know
Calculating Reserves:
The specific calculation is the total amount of liquid assets remaining after the loan transaction closes divided by your monthly mortgage payment including taxes and insurance. For example, if you have $20,000 in reserves an your monthly payment is $2,000, then you have 10 months worth of reserves.
Unacceptable Sources of Reserves
The following cannot be counted as part of the borrower’s reserves:
- Funds that have not been vested;
- Funds that cannot be withdrawn under circumstances other than the account owner’s retirement, employment termination, or death;
- Stock held in an unlisted corporation;
- Stock options and non-vested restricted stock;
- Personal unsecured loans;
- Cash proceeds that will be the result of a cash-out refinance
The total amount of reserves required per transaction is determined by the perceived riskiness of the loan. The criteria used to determine risk includes, but is not limited to the transaction type, number of units, loan-to-value ratio, credit score and DTI.
Liquid Reserve Requirements range from 0 months up to 12 months depending on the mix of the aforementioned criteria. As a rule of thumb, you should expect to be required to have at least 3 months in reserves to qualify for a loan.
Higher amounts of liquid reserves are considered more favorable than lower amounts or no reserves. Research has shown that mortgages made to borrowers with higher amounts of liquid reserves tend to have lower delinquency rates.
Typically, primary residences have the lowest reserve requirement, second homes have the second highest requirement and investment properties have the highest requirement. The final number, however, is determined by the lender. Most lenders determine the exact amount by using a quantitative modeling tool provided to them by Fannie or Freddie.
