What Are Mortgage Reserves?

Mortgage Reserves are a significant part of the loan approval process.

When lenders consider approving a mortgage application, they want as little risk as possible. This is why they have minimum mortgage reserve requirements. To decrease their risk, lenders prefer that buyers have some sort of “fallback” if things go wrong. For instance, you lose your job or your income declines. The term “mortgage reserves,” simply means funds you can get your hands on fast if you need it.

When Do You Need Mortgage Reserves?

You typically don’t need reserves when purchasing a primary residence or second home. But if your credit score is a little low or if you’re buying a multi-unit property’ investment property or getting a jumbo loan then you most likely will need them.

Calculating Mortgage Reserve Requirements

Liquid reserves are financial assets that are available after a loan closes. Reserves are calculated based on the total amount of liquid assets remaining after the loan transaction closes divided by the total monthly housing payment amount, including, principal and interest, property taxes, property insurance, mortgage insurance, flood insurance and any association/condo association dues.

Let’s say that your total monthly housing costs will be $1,000. If the lender says you need two months reserves you must have $2,000. If your monthly housing cost is $1,500 then you would need $3,000.

The good news is that lenders see liquid assets as anything that can be quickly converted into cash, including stocks, bonds, mutual funds, the cash value of an insurance policy, accessible retirement funds, and certificates of deposit.

Will Borrowed Funds Count Towards Reserves?

They will if the borrowed funds were secured against a property or a vehicle that you own. If the funds were from an unsecured source, like a credit card, unsecured credit line, or from a family member and were deposited within the last two months, then they won’t be considered as eligible mortgage reserves. If they were deposited over two months ago, then they will be considered “seasoned funds” and be accepted as mortgage reserves.

Will Gifted Funds Count Towards Mortgage Reserves?

Freddie Mae and Freddie Mac conventional mortgages, along with FHA and VA loans, will allow gift funds to be counted towards mortgage reserves.

Compensating Factors

Mortgage Reserves, even when reserves are not required to qualify for a home loan officially, they can serve as a compensating factor for marginal applicants. As an example, VA and FHA say, compensating factors may affect the loan decision, and these factors are especially important when reviewing loans which are marginal with respect to residual income, low credit scores or high debt-to-income ratios.