To get a handle on mortgage reserve guidelines, one needs to understand what liquid financial reserves are and what purpose they serve. Simply stated, liquid financial reserves are funds or assets that are easily converted to cash and available to the borrower after the mortgage closes. These savings are seen as an emergency fund to mitigate the risks of a mortgage default in the event of financial hardship. There are several sources of liquid reserves accepted by lenders, including:
- Checking or savings accounts
- Stock or bond investments
- Certificates of deposit
- Trust accounts
- Money vested in a retirement savings account
- The cash value of a vested life insurance policy
Financial reserves are calculated based on the total amount of liquid assets remaining after the loan transaction closes, divided by the total monthly housing payment amount, including principal and interest, property taxes, insurances, and any association dues (in the financial industry, these five factors are referred to by the acronym PITIA).
Lenders may have different requirements on the numbers of months your cash reserves should cover. For conventional loans, they may require up to six months’ worth of mortgage, depending on credit score, debt-to-income (DTI) ratio, loan-to-value (LTV) ratio, and number of units. The required liquidity will also depend on the number of other financed properties the borrower currently owns.
If the borrower owns multiple financed properties, additional reserves must be factored in for financed properties other than the subject property and the borrower’s principal residence. Pursuant to Fannie Mae’s underwriting guidelines, the reserve amount will then be determined by applying a specific percentage to the aggregate of the outstanding unpaid principal balance (UPB) for all mortgages and HELOCs disclosed on the online loan application.
It is important to stress, however, that not all borrowers need to produce a cash cushion. Those that qualify for certain loan types or are buying a single-family home they plan to live in will often be exempt from liquid financial reserves.
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