Applying for a mortgage means more than getting approved for the loan and closing on it. You have to have money to close it and not always money for the closing costs. Sometimes you’ll need what a lender calls cash reserves. This is money in some type of liquid account that you could access should you be unable to make your mortgage payment with your standard income.
Not all mortgage programs require cash reserves, but they can certainly help sway a lender in your favor should you be a ‘borderline’ borrower.
What are Cash Reserves?
First, let’s look at the definition of cash reserves. As the name suggests, it’s cash that you have ‘on reserve.’ The account must be one you can liquidate on demand, such as a checking or savings account. Reserves can also be in things like stocks or bonds – anything you can turn to cash quickly.
Cash reserves are not funds you need now. They are funds that sit there for a ‘rainy day.’ Lenders like to see these funds because they provide reassurance that you’ll be able to pay for emergencies that come up, such as leaking pipes or a broken water heater.
Who Needs Cash Reserves?
Not every borrower needs cash reserves. If you are buying a single-family residence that you intend to live in full-time you probably won’t need reserves. If you buy a multi-unit property or an investment/vacation home, count on needing reserves, though.
But there are some people that will still need reserves even if you buy a single-family property. These borrowers are those with less than perfect credit or any other negative aspect to their loan application. Let’s say you are applying for a conventional loan, but you just get by with the approval. Your credit score is at the minimum required credit score and you have a slightly elevated debt ratio. What may sway a lender is the fact that you have cash reserves on hand. They know the mortgage won’t put you over the edge financially.
How to Calculate Reserves
Calculating reserves is important. You wouldn’t just say that you have $4,000 on hand. Instead, you would determine how many months of mortgage payments the amount you have saved would cover. Let’s say for simplicity’s sake that your mortgage payment is $1,000. That means $4,000 in savings would be four months of reserves.
Every lender requires a different amount of cash reserves. One lender may even have different cash reserves requirements for different borrowers. It depends on your financial situation and whether the reserves are required or would be a nice compensating factor.
So do you need cash reserves? Chances are that you won’t need them, but they can definitely help your situation. If you want a lender to approve your loan application, it’s a good idea to show money that you have saved for a rainy day. Even if you don’t need the money to cover your mortgage payment, they can serve as emergency funds for anything that goes wrong with your home. Basically, they show a lender that you have the financial capability to handle anything thrown your way, which makes you a low risk of default.