Like most borrowers taking out a mortgage to buy a home, you’ll need a significant amount of cash to cover the deposit, down payment, and other costs. In some cases, you may also need something called a cash or mortgage reserve. Lending institutions will require proof of these assets before approving your loan application.
What is a mortgage reserve?
Mortgage reserves refer to cash or other assets that are readily available to pay your loan. If your mortgage lender requires reserves, these reserves are in addition to the cash you use for your earnest money deposit, down payment, and closing costs.
“Mortgage reserve requirements do not vary by lender, but are typically tied to the type of loan and the level of risk associated with it,” says Matt Dunbar, senior vice president, southeast region, at Churchill Mortgage. “Reserves act as a risk mitigation measure, with higher-risk loans and low-capitalization situations making reserves more likely to be required.”
However, you may not need a reserve for your mortgage. This depends on your credit and financial situation, the type of property you’re buying, and the type of loan you get. The reason lenders require a reserve is because they want to ensure that you have a sufficient amount of savings or other liquid assets that can be used to make mortgage payments as a backup for your salary or wages.
Mortgage reserves are calculated on a monthly basis, so for example, if your lender requires four months of reserves, you’ll need the equivalent of four monthly mortgage payments, either in savings or another asset that you can easily tap into.
What assets qualify as mortgage reserves?
“Homebuyers should have enough in reserve to cover six months’ worth of mortgage payments,” says Greg McBride, chief financial analyst at Bankrate, “but that doesn’t necessarily mean putting it all in a savings account; investments placed in fully vested retirement or brokerage accounts also qualify.”
While cash in checking and savings accounts usually counts as reserves, there are other types of assets that may qualify. For a conventional loan, these include:
- Funds secured in retirement accounts such as 401(k)s and Roth IRAs
- Stocks, bonds, mutual funds, money market funds
- Fixed term deposits (CDs)
- Cash value of fixed life insurance policies
- Funding of the Trust
For some types of loans, mortgage lenders can only count up to 60% of committed funds as qualified reserves.
What assets do not qualify as mortgage reserves?
The following types of assets generally do not qualify as mortgage reserves for conventional loans:
- Funds in an account that have not yet been fully vested
- Funds that you can’t access until you leave your job, or funds that you can only access if you lose your job or die
Unsecured loans (such as personal loans)
- Funds obtained through cash-out refinancing of real estate
- Lender contributions
- Unlisted company shares
When do I need a mortgage reserve?
Most borrowers don’t need a cash reserve for a mortgage unless they’re buying a certain type of property or have favorable terms for their application, such as poor credit, a small down payment, or a high debt-to-income ratio (DTI). For example, a homebuyer with a credit score below 700 and a down payment of less than 20% may need a six-month reserve.
Even if a homebuyer makes a large down payment, they may still need a mortgage reserve if their credit score is in the 600s. In these cases, lenders may require a reserve that is enough for two to six months of mortgage payments.
Self-employed borrowers may also need a reserve fund, especially if they don’t have a steady paycheck or regular source of income.
If you’re a real estate investor, you may also need cash reserves that are visible to your mortgage lender, especially if your repayment plan is based on the income (rent or lease payments) you receive from the property you’re borrowing against.
“Jumbo loans and investment properties typically come with reserve requirements. Additionally, if a lender has exceptions or risk factors that exceed the general guidelines, having verified reserves can be a key factor in securing loan approval,” says Dunbar. “These reserves provide additional peace of mind to lenders and ensure borrowers can manage payments even if there are unexpected changes in their financial situation.”
How much is the mortgage reserve?
If you need a mortgage savings account, the amount you need typically depends on the type of loan you apply for and the type of property you’re buying. Each lender sets its own criteria, but here are the terms outlined by Colorado-based lender American Financing:
| Conventional Loans |
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| FHA Loans |
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| VA Loans |
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| USDA Loans |
| Primary residence | Up to 6 months |
| A second home | 2 to 4 months or more |
| Investment Property | 6 months or more |
How to save for a home loan
If your mortgage lender indicates you’ll need a reserve and you don’t have many assets, you may need to take steps to build up your savings before applying for the loan. Here are some tips:
1. Cut expenses
Look at your budget and see if you can cut back on spending. For example, you could cancel subscription-based services you don’t use often, shop smarter at the grocery store, or find a cheaper provider for auto insurance. Set aside those savings in an account that you don’t want to withdraw but can easily access in an emergency. This could be a checking or savings account that’s separate from the account you use for bills and everyday expenses.
2. Save a portion of your income
Savings accounts qualify as mortgage reserve funds, so putting a portion of your income into one of these accounts each month can help you grow your savings. To make saving even easier, consider setting up automatic deposits.
3. Consider CDs
If the interest rates on your savings account aren’t enough for you, and you don’t plan on taking out a mortgage anytime soon, consider a certificate of deposit (CD). CDs are a good reserve asset, and interest rates on CDs tend to be higher than those on savings accounts, so you can earn a higher yield.
4. Entering the financial market
Money market accounts (MMAs) offered by banks and credit unions are a combination savings and checking account that tend to earn more competitive interest rates on the funds you deposit. MMAs offer lower yields than CDs, but they’re also more liquid, and you can withdraw your money via debit card or check.
A similar investment vehicle is the money market fund, a type of mutual fund offered by brokerages and investment companies that generates income from short-term securities and often offers higher rates of return than savings accounts and money market funds. It is also classified as a low-risk investment (but because it’s not a bank account, it’s not FDIC insured). Keep in mind that while both MMAs and money market funds are highly liquid, they can have high minimums to open and maintain an account.
5. Increase your contributions to retirement accounts
Mortgage reserves can also be funded from defined retirement savings. If you’re only contributing the minimum amount to your retirement account, consider increasing it.
6. Save money from extra income
If your job regularly gives you bonuses, you work on commission, or you regularly receive large tax refunds, get into the habit of setting aside some or all of that money as a cash reserve.
