Since I read this article by Maggie McGrath over at Forbes in early January, I’ve been turning it over and over. If you didn’t see it when it exploded onto social media, the gist is that most of America doesn’t have $1,000 in liquid cash at any given time. By the majority, I mean, 56 to 63 percent, depending on which study you’d like to cite.
I guess I always assumed that most Americans were much better at resisting temptation and socked away money like the responsible adults they are. Because of my unwavering faith in your financial savvy, we never really talked about one of the biggest hurdles to securing a mortgage: assets and reserves. We’re going to discuss it today, because it seems we all need a little help navigating the financial world.
Assets and Reserves Basics
We should all be kind of familiar with the concept of assets. They’re stuff we own that’s worth something, or just raw currency. It all boils down to owning something that the general public would say has a recognized value. That means that those bonds your grandmother got you for your high school graduation are assets — they have a recognized value to the wider world — and your baseball card collection isn’t. I don’t care how many Jose Canseco rookie cards you have, that’s not generally considered an asset for a regular person who doesn’t sell baseball cards for a living.
But, things like CDs, money market accounts, savings accounts, bonds and cash in hand are assets. Your stash of gold pirate coins are assets. That’s the easy part — the part that’s not all that complicated. In practical terms, assets have value to the general public and are not unreasonably difficult or expensive to liquidate.
Reserves are another thing. In fact, they’re a scary thing for a lot of buyers. They’re a specific class of traceable, liquidatable assets that can help a bank assess your ability to repay your mortgage, were you to hit a rough financial patch. They can be required for any type of loan, but this varies significantly between programs and borrowers. Basically, reserves are a bank’s way to prove to themselves that you can make a certain number of PITI (payment, interest, taxes and insurance) payments before you run out of funds.
This is why I was so alarmed when I read about how little available cash Americans have today. I wondered how it would affect the real estate market moving forward and if lenders would eventually adapt to embrace people who couldn’t really produce large reserves, closing costs and down payments. You’re out there looking at homes, you already know how all these things can add up — $1,000 won’t even touch it most of the time.
There’s More Than Cash to Reserve Assets
If you’ve got a big savings account just lying around, you’re probably set, but in the event that you don’t, you’ll have to dig deep and hunt up those alternative sources for reserves if they’re required for your loan. If you’re vested in your 401(k) or similar retirement plan, own an IRA that you contribute to regularly or have a fully vested whole life insurance policy, you don’t need a big pile of traceable cash — you just need a statement or two to show that your funds are your own and available if you were to need them.
Using Gift Money for Reserves
Ah… now this is the sticky wicket, isn’t it? Gift money and recently liquidated assets can be major problems for you. See, when you dump a bunch of money into a bank account or a retirement account, the Federal government gets twitchy. Because of the Patriot Act, passed in 2001, you can’t just produce money you’ve been hiding in your bedroll and expect your lender to accept it. They have to have a paper trail, so they can be certain that your surprise cash didn’t come from some unsavory source.
Gift money can be done, it’s possible — but here’s what you need to know about that:
- Gift money can only come from family members. A large gift will have to be documented and a gift letter signed by someone — and then a paper trail established from there. So, if your parents gave you $15,000 to help with your down payment, not only will they need to provide a written statement to that effect, they’ll need to provide bank statements showing that it was totally legit. Gift money from friends is a harder one — if you have a friend who’s willing to pony up a big chunk, be thankful, but hold off applying for a loan for several months to a year. Brand new gift money from outside close family is one of the hardest things to handle in the world of mortgages — leaving it in an account can help prove you’re not laundering money for your pals and give the bank enough of a paper trail to eventually allow it for your reserves, down payments and so forth. (To clarify, your lender obviously can’t control what you do with your money, but they can discount money they can’t trace from your assets and reserves, meaning you’d not qualify for the loan in the first place.)
- You can sell stuff, but do it ahead of time. If you’ve been thinking about selling your extra car to free up some equity and add to your house buying fund, you’ll need to plan ahead. Do this three, four, even six months before you ever apply for a loan. Put that money in the bank and leave it there. Then don’t touch it. At least until closing. Your mortgage bank will usually go back about three months to verify your funds and reserves — if they see a big deposit that seems to exceed what’s possible with your income, they’re going to ask a lot of questions. You’ll need to provide proof of the sale of whatever you sold; it can get very complicated. If you plan ahead and give the money time to age in your account, there’s less of a chance that you’ll have to find that bill of sale you scribbled hastily for the out of state buyer of your old truck.
So, How Much Will I Need in Reserves?
You’re already worried that you won’t be able to come up with enough money to close — I can see you worrying through the computer screen. Don’t fret, most of the time reserves are a slam dunk. But, I’ll walk you through how much you may need, depending on your loan type. Here we go.
FHA Loan
I’m starting with FHA because typically, they don’t require reserves when you’re buying a single family home or a duplex. If you’re looking into three or more units, the standard is three months worth of payment, interest, taxes and insurance in reserves.
VA Loan
VA is similar to FHA, in that it doesn’t require reserves for a single or two family property — most of the time. If you own rental property that’s not secured by a VA loan, you’ll need three months of reserves for each property owned (not each unit, each property). You’ll also want to bring an additional six months of reserves if you plan to purchase a property that’s made up of three or more units.
USDA Loan
Generally speaking, USDA doesn’t require any reserves. However, if your credit score is really low they may ask for proof of cash after closing. Cash in hand with a USDA loan can be a tricky thing to negotiate, though, since they determine your rate based on your income and assets. Speak to a USDA office before you decide what to do with your lottery winnings if you plan to use this program.
Conventional Loan
I’ve told you before that conventional loans can be very hard to qualify for, but they also make the best loans for people who are planning to pay them off entirely. That being said, they’re also tricky when it comes to reserves. The rules on reserves for Conventionals are complex, but in general, if your loan is automatically underwritten and you don’t own other properties, you probably won’t need reserves. Manually underwritten loans are more complicated, so I built a chart (yay charts!):
Reserves Required for Fixed Rate Conventional Mortgages for Owner-Occupied Purchases
| Number of Units | Debt to Income ≤ 36% | Debt to Income ≤ 45% | ||||
| Min. Credit Score | Loan to Value | Reserves (Months) | Min. Credit Score | Loan to Value | Reserves (Months) | |
| 1 | 680 | 76 to 95% | 0 | 700 | 76 to 95% | 0 |
| 620 | up to 75% | 0 | 640 | up to 75% | 0 | |
| 660 | 76 to 95% | 6 | 680 | 76 to 95% | 2 | |
| – | – | – | 620 | up to 75% | 2 | |
| 2 | 680 | 76 to 85% | 6 | 700 | 76 to 85% | 6 |
| 640 | up to 75% | 6 | 660 | up to 75% | 6 | |
| – | – | – | 680 | 76 to 85% | 12 | |
| – | – | – | 640 | up to 75% | 12 | |
| 3 or 4 | 660 | up to 75% | 6 | 680 | up to 75% | 6 |
| – | – | – | 660 | up to 75% | 12 | |
Jumbo Loan
We’ve touched on Jumbos before — they’re even more confusing than Conventionals, and the rules are significantly more fluid. Basically, your bank will assess your individual risk and then decide what your reserves should be. There will be reserve requirements, to be sure, and they can vary from about six months to several years worth.
The Bottom Line: Reserves Don’t Have to End Your Real Estate Adventure
I know a lot of you are worried about all this money that you have to come up with out of thin air, but the fact of the matter is that reserves aren’t as big of a deal as they seem. Yes, you need to be able to show the bank you have a source for these funds, but you don’t have to cough them up or cash in your life insurance or anything — it’s all on paper.
Think of them like a parachute. You don’t have to use them unless you’re in an emergency situation, but your bank’s going to want to make sure they’re able to be deployed if needed. Having reserves is actually a smart move for everybody, they ensure that you’ll be able to make your house payments even if something goes terribly wrong financially.
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