You may think that cleaning out your bank account to make a large down payment on a house would be a smart move, but that’s inaccurate. You should have money left over in mortgage reserves so you’ll be able to pay your loan principal, interest, taxes and insurance if you experience a loss of income. Mortgage reserves are expressed in terms of the number of months you can cover all those costs.
Why Might Mortgage Reserves Be Required?
You may or may not be required to have mortgage reserves. Whether you will need reserves—and how much—will depend on your lender, the type of mortgage, the type of property, your credit score, your loan-to-value ratio and your debt-to-income ratio.
A lender may require mortgage reserves if you’re self-employed, make a small down payment, plan to purchase a rental property or already have one or more mortgages. Reserves can give the lender confidence that you’ll be able to cover your housing payments and will be unlikely to default.
Compensating factors, such as substantial mortgage reserves, can help if you’re a marginal applicant. If you might not qualify for a loan because of your limited income, low credit score or high debt-to-income ratio, you may have a better shot at getting approved if you have substantial mortgage reserves.
What Are Acceptable Sources of Mortgage Reserves?
Sources of funds that can be quickly converted to cash are considered liquid reserves. You may have reserves in the form of checking and/or savings accounts, retirement accounts, trust accounts, stocks, bonds, certificates of deposit and life insurance.
Borrowed funds become “seasoned” after two to three months, then they can be considered savings. You may be able to count funds from a personal loan as cash reserves if you took out the loan a few months before you got a mortgage. The lender will then consider the money “seasoned” assets and will include monthly loan payments in your debt-to-income ratio.
If you receive money as a gift, you’ll be able to include that in your mortgage reserves. The lender will require proof that the funds didn’t come from a loan that you’ll have to repay.
Reasons to Have Mortgage Reserves, Even If They Aren’t Required
You should have access to mortgage reserves, whether your lender requires them or not. Mortgage reserves may help you qualify for a loan with better terms, which may help you save money on the overall cost of a loan. Having access to funds that can cover essential living expenses can give you peace of mind since an unexpected job loss, injury or illness can occur at any time.