Some mortgage lenders require home buyers to have a certain amount of “cash reserves” in the bank before closing on a home loan. In theory, the borrower can use these funds to cover their first few mortgage payments, reducing risk for the lender.
Here are five key points you should know about cash reserves:
- Cash reserves are funds left over after closing that could cover several months of housing payments, including mortgage, taxes, and insurance.
- Some lenders require them to ensure that borrowers can continue making payments in case of financial hardship.
- Cash reserves are often required for riskier loans, such as larger “jumbo” mortgages or investment property loans.
- If you’re using a standard conforming loan, or a government-backed mortgage like FHA, you might not need to have cash reserves.
- If reserves are needed, the borrower will have to provide documentation (e.g., bank statements) to show they have the required funds.
Next, we will explain what cash reserves are and why some mortgage lenders require them.
Definition of Cash Reserves, in a Mortgage Context
When mortgage lenders mention “cash reserves,” they are talking about extra money the borrower has in the bank at the time of underwriting and closing.
Cash reserve requirements are typically expressed in terms of monthly mortgage payments. For instance, a lender might require borrowers to have three months worth of payments in the bank at closing.
This is above and beyond the amount required for the down payment and closing costs, by the way. It’s extra money kept in reserve to cover the monthly payments – hence the term.
Why Some Lenders Require Them
Why do some lenders have cash reserve requirements? In a word, risk.
When borrowers have additional money saved up, they are less likely to miss their mortgage payments — at least the first few payments. Lenders are mostly concerned about your ability to make payments in the short term versus the long term. Here’s why…
Your mortgage lender may not keep your loan on its books for very long. They might sell it into the secondary market through Freddie Mac and/or Fannie Mae (the government-sponsored enterprises that buy and sell bundled loans).
Once the lender sells the loan into the secondary mortgage market, it no longer poses a risk to them in the form of borrower default. Cash reserves offer the lender a degree of protection during those first few months (or six months, or even 12 months depending on the situation).
But the process of selling a loan to Fannie Mae or Freddie Mac can take some time. Cash reserves ensure the borrower can continue making payments during this period, reducing the risk of default.
A mortgage lender might have additional reasons for requiring reserves. But this is the main reason, in most cases.
Situations When Reserves Are Not Needed
Cash reserves are not an industry-wide standard or requirement. They can vary from lender to lender.
Some lenders require them, while others do not.
There are even variations among those lenders that do require them. For instance, some lenders might have a requirement of two months worth of cash reserves, while another has a more stringent six-month requirement.
As mentioned earlier, it usually comes down to risk. If a certain borrower/loan profile increases risk for the lender, they’re more likely to require cash reserves.
For instance, “jumbo loans” that are too big to be sold to Fannie Mae or Freddie Mac often require up to 12 months worth of cash reserves. These loans are often sold to private investors or investment groups, which can take longer.
On the other hand, a borrower with good credit seeking a smaller “conforming” loan might not be required to have cash reserves. Or they may only need 2 to 3 months worth.
Lenders typically disclose these requirements upfront. Or at least they should. After all, it doesn’t make sense working with a borrower who lacks the reserves needed to qualify for a loan.
But it’s always wise to be proactive. When applying for a mortgage or getting a quote from a lender, ask them about their cash reserve requirements. This will prevent unpleasant surprises later on.
Frequently Asked Questions From Home Buyers
Here are some of the key points and frequently asked questions covered in this guide.
What are cash reserves in a mortgage context?
Cash reserves refer to the funds a borrower has available after closing on a home purchase. These funds act as a financial cushion, helping the borrower cover their monthly mortgage payments even in the event of a lost job or income disruption.
Do all lenders require them?
Not all lenders require cash reserves, especially when it comes to government-backed loans like FHA or VA loans. However, reserves may be required for conventional loans or for borrowers with a higher risk profile.
According to Bankrate.com: “Most borrowers don’t need a cash reserve for a mortgage unless they’re buying a certain type of property or their application could use a boost due to poor credit, a low down payment or a high debt-to-income (DTI) ratio.”
Is it separate from my down payment?
A down payment is the amount of money you pay upfront toward the purchase of the home. You’ll submit your down payment at closing, as an investment in the home. Cash reserves, on the other hand, are funds set aside to ensure you’re able to make mortgage payments after buying the home.
How many months of cash reserves do lenders require?
This can vary depending on the type of loan being used, the borrower’s credit profile, and the lender’s business model. Lenders that require cash reserves often want to see 2 to 6 months’ worth. Higher-risk jumbo loans might require more.
How do mortgage lenders verify that I have them?
Lenders typically verify cash reserves by reviewing the borrower’s bank statements, savings accounts, investment accounts, etc. The documentation must show the necessary amount and, in some cases, an account history that shows the funds have been there for a certain period of time.
What types of assets count as cash reserves?
Cash reserves typically include funds in savings accounts, checking accounts, money market accounts, and other liquid assets like stocks, bonds, or mutual funds. Some lenders may allow retirement accounts as well (e.g., 401k and IRA), but often only a percentage of those funds.
Can I use gift funds to meet this requirement?
Gift funds are money provided by a third party, like a parent or relative, to help the home buyer cover their down payment and closing costs. Depending on the type of loan you’re using, you might also be able to use gift funds to meet the lender’s cash reserve requirement. But you’ll want to ask about this up front, if it’s a concern.
Are cash reserves required for refinancing?
Some lenders may require cash reserves when refinancing a mortgage, especially for investment properties or higher-risk loans. The requirement for reserves is more common in cash-out refinances or non-conventional loan products.
Can I use a line of credit or a personal loan?
No, funds from a line of credit, personal loan, or borrowed money typically do not qualify as cash reserves. Lenders want to see that the funds are your own and that they are not borrowed, as this would increase your debt load.
How do cash reserves affect my mortgage application?
Having strong cash reserves can improve your mortgage application and potentially lead to better terms, especially if you’re a higher-risk borrower. Even if reserves aren’t required, having additional savings can make your application more appealing to lenders.
Are they required for jumbo loans?
A jumbo loan is a mortgage product that exceeds the conforming loan limit where the home is located. They’re often used in expensive real estate markets and/or for purchasing high-end properties. Jumbo loans often require additional cash reserves due to the higher risk. Lenders might ask for 6 – 12 months of reserves, or even more.
Are cash reserves required for FHA loans?
Cash reserves typically aren’t required for FHA loans used for a primary residence, but might needed in a duplex or triplex scenario. According to the HUD.gov website: “cash reserves after closing are not required on FHA mortgages (except when purchasing 3- or 4-unit properties) but are evaluated in determining the risk classification of the loan.”
Disclaimer: Different loan programs and lenders have different requirements. As a result, portions of this guide might not apply to your particular situation. Borrowers should ask their lenders about cash reserve requirements up front, when first applying for a loan.
Brandon Cornett
Brandon Cornett is a veteran real estate market analyst and reporter. He has been covering the U.S. real estate market for nearly 20 years. More about the author