What Are Mortgage Reserves?

What qualifies as mortgage reserves?

Mortgage reserves are funds you can easily access and use to make your mortgage payments if you’re temporarily unable to use your ordinary income to do so (such as if you lose your job or fall ill).

In most cases, mortgage reserves are the remaining cash you have on deposit with a financial institution after you make the down payment and cover any closing costs. These assets can include money you hold in a checking, savings, money market or certificate of deposit (CD) account.

However, other types of assets you can quickly and easily liquidate can also be considered mortgage reserves. A few examples include:

• Publicly traded stocks
• Bonds
• Mutual funds
• Cash surrender value of a life insurance policy
• Vested funds held in retirement savings accounts

What doesn’t qualify as mortgage reserves?

Assets that can’t be quickly turned into cash aren’t acceptable mortgage reserves. For example, stock in a private corporation (e.g., your brother-in-law’s small business) wouldn’t be acceptable because it’s unknown how much the stock would sell for or how quickly it would sell. Also, stock or retirement savings that haven’t yet vested (can’t be cashed out) aren’t acceptable.

Additionally, most loan proceeds can’t be used as mortgage reserves. For instance, availability on an unsecured personal loan or credit card doesn’t qualify, as you may be unable to access these funds in a financial emergency. Similarly, funds from a cash-out refinance on your home usually aren’t acceptable mortgage reserves.

When mortgage reserves are needed

When you apply for a home mortgage, lenders evaluate various criteria to see if you qualify for the loan. Mortgage reserves are one common type of criteria.

Although the specific requirements vary by lender and the type of mortgage, lenders commonly require cash reserves to help mitigate their risk, explained Dennis Shirshikov, head of growth at Awning, a real estate company serving property owners and investors.

The amount of mortgage reserves you’ll need can depend on such things as the type of loan, your credit score and your debt-to-income ratio, said Shirshikov.

“Picture this: You’re a lender, and you have two applicants for a mortgage. One has a solid reserve of cash set aside, and the other lives paycheck to paycheck. As a lender, you’d feel more secure lending to the applicant with reserves, right? That’s essentially why reserves are required — it gives lenders that extra reassurance,” he said.

Some factors that affect the need for mortgage reserves include:

• Credit score: Lenders may require lower or no minimum cash reserves if you have a fair-to-good credit score (e.g., 660 to 720).
• Debt-to-income (DTI) ratio: Lenders commonly require borrowers to have DTI ratios of no more than 36% to 45%. The higher your DTI ratio, the more cash reserves you may need.
• Loan-to-value (LTV) ratio: Borrowers who can make larger down payments or with more equity in their home are typically viewed as a lower risk. The minimum cash reserve requirements may also be less.
• Occupancy status: If the mortgage is used to finance your primary residence, the cash reserves may be lower than to finance a second home or rental property.
• Property characteristics: If the property is a single-family residence, the minimum cash reserve requirements may be less than if you’re financing a property with two to four residential units.
• Mortgage type: Each type of mortgage has its own requirements. For example, the cash reserve requirements for conventional loans may differ from those required for a FHA or VA loan. Similarly, you might need larger cash reserves for a cash-out refinance than you would for a standard loan to purchase a home.

How lenders calculate mortgage reserves

During the mortgage pre-qualification and approval process, your lender will test how many months your liquid assets can cover your mortgage payments and related housing costs, such as insurance premiums and real estate taxes.

The number of months’ worth of mortgage reserves you’ll need will depend on your loan risk. Low-risk loans may not require any reserves, whereas you might need reserves sufficient to cover your housing costs for at least two to six months for higher-risk loans.

For example:

• If you have a credit score of at least 680, your DTI ratio is 36% or less and you have at least 5% equity on your single-family home, you might not need any cash reserves.
• In the same scenario, you might need six months’ reserves if your credit score is less than 660.

You don’t need to set this money aside in a separate account, and your lender won’t hold it as collateral. Instead, you’ll provide documentation during the loan approval process to verify you have enough liquid assets to meet the mortgage reserve requirements. For example, you may need to provide bank or brokerage account statements for the most recent three months.

» MORE: How to get preapproved for a mortgage

How long do you need to keep mortgage reserves?

You’re only required to maintain mortgage reserves through closing, not afterward. Once your loan funds and you receive the keys, lenders don’t monitor your bank accounts or require you to keep specific reserve amounts. The money becomes yours to use as needed.

Before spending your reserves, review your loan documents carefully. When in doubt, contact your lender directly to confirm whether your loan includes any ongoing reserve requirements.

However, several important exceptions exist:

• If you’re using rental income to qualify for your mortgage, some lenders may stipulate ongoing reserve requirements in your loan agreement.
• Portfolio loans or non-QM mortgages sometimes include reserve maintenance clauses.
• If you’re securing multiple investment properties simultaneously, lenders may require you to maintain reserves across your portfolio.
• Some agreements include specific provisions about maintaining funds, and violating these terms could trigger penalties or acceleration clauses.

Despite no legal requirement, financial advisors strongly recommend keeping these reserves intact. Life events like job loss, medical emergencies or major home repairs can quickly derail your budget. Having three to six months of mortgage payments saved provides crucial breathing room and helps you avoid default or foreclosure.

How to build your mortgage reserves

You can build your mortgage reserves using the same process as any other savings goal: Figure out how much money you need to save and how much time you have to meet your goal.

When you’re saving to buy a house, you should include in your budget funds to:

• Cover the required down payment (typically 3% to 10% of the purchase price)
• Pay for closing costs (typically 2% to 5% of the loan amount)
• Make any desired home improvements
• Buy furniture or appliances
• Build an emergency fund (including money you can use for mortgage payments)

A good rule of thumb is to build an emergency fund sufficient to fully cover at least three to six months of living expenses. This should give you a cushion above and beyond what’s required to get a mortgage.

After you’ve set your savings goal, evaluate your household budget and consider how you can adjust to get there. For example, you might try to reduce your expenses by eating at home more often. Or you could automatically put a portion of your paycheck into a savings account.

If you need help creating a savings plan, a financial counselor may be able to help you get started. Lots of banks offer these types of services for free. Plus, you may even be able to get free or low-cost financial help from a nonprofit credit counselor.

» MORE: How much house can I afford?

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