This Article Is About The Reserves Requirement On Home Loan By Mortgage Lenders

Reserves are recommended for all homeowners but are not required on files that gotten an approve/eligible per automated underwriting system findings on single-family homes. All FHA and VA manual underwrites require one month’s reserves. Multi-family family homes require reserves. Reserves cannot be gifted and need to be the borrower’s own funds. In this article, we will discuss and cover the reserve requirements on home loans required by lenders.

What Are Closing Costs

Closing costs are any costs and fees incurred in the transaction of the home purchase and/or refinance transaction. This can be either costs and fees that are directly and/or indirectly related to the borrower.

Examples of closing costs are the following:

• title charges
• appraisal fees
• tax and insurance escrows also called prepaid
• one year insurance premium
• attorney fees
• other fees such as recording charges and other fees and costs related to the property purchase
• Sellers concession can be used to pay for closing costs
• If the borrower is short to pay closing costs with seller concession, then lender credit by the mortgage lender can be used

FHA allows a maximum of a 6% seller’s concession towards a buyer’s closing costs. Conventional loans require up to a 3% maximum seller’s concession towards a buyer’s closing costs.

Any excess in closing costs needs to go back to the sellers. Homebuyers need to make sure they do not get extra closing cost sellers concessions.

Closing Cost On Home Purchase And Refinance Transactions

All mortgage transactions, whether they are purchase and/or refinances, have closing costs. Most homebuyers do not have to come up with any closing costs. Closing costs are covered with sellers concessions and/or lender credit. Mortgage Reserves are normally not required by lenders on single-family home purchases.

• However, there are cases where the Automated Underwriting System will condition mortgage reserves

This normally happens with borrowers with the following:

• Lower credit scores
• Prior derogatory credit items
• Outstanding collections
• Charge offs
• No credit tradelines

When Does Automated Underwriting System Require Mortgage Reserves

Fannie Mae and Freddie Mac Automated Underwriting System normally do not require mortgage reserves on single-family home purchases.

• Borrowers with decent credit and stable income, the mortgage lender will not require any mortgage reserves

Reserves are conditioned by AUS on borrowers with less than perfect credit:

• Recent Late Payments
• Under 600 credit score borrowers
• Late Payments After Bankruptcy and/or Foreclosure
• Outstanding Collections and Charge Off Accounts
• High Debt To Income Ratio Borrowers

Although mortgage reserves might not be required by the mortgage lender, first time home buyers should always have several months of mortgage reserves:

• This is due in the event home needs emergency repairs

I will cover some case scenarios where mortgage reserves can be a form of insurance when things can go very wrong.

When Do Lenders Require Reserves

When Do Underwriters Ask For Reserves Requirement On Home Loan?

Reserves Requirement On Home Loan is normally not required. Reserves are highly recommended for home buyers even though it is not conditioned by mortgage lenders. When a borrower applies for a home loan, the mortgage loan originator will submit the applicant’s mortgage application and credit reports to Fannie Mae’s and/or Freddie Mac’s Automated Underwriting System for automated approval. If it is run through Freddie Mac, then the results will be approve/eligible per LP FINDINGS. If it is submitted through Fannie Mae, then the results will render an approve/eligible per DU FINDINGS. Most lenders favor Fannie Mae’s Automated Underwriting System.

Down Payment and Closing Cost Requirements by Lenders

To qualify for an FHA loan, borrowers must have a minimum credit score of 580 to qualify for 3.5% down payment.

Borrowers with credit scores between 500 and 579, a 10% minimum down payment is required on a home purchase. The Federal Housing Administration (FHA) allows 100% of the down payment to be gifted from a relative or family member.

A 5% minimum down payment is required for a home purchase. This is for single-family homes or condominiums. 3% down payment on conventional loans for first-time homebuyers.

Fannie Mae and Freddie Mac define first-time home buyers as those who did not have ownership of a home for the past three years. 15% minimum down payment is required for two-unit residential properties.

Conventional loans require a 620 credit score. Besides the down payment, there will be closing costs.

Reserves Requirement On Home Loan By AUS

There are times when the Automated Underwriting System will require reserves. Reserves required by lenders are monthly payments of the new housing expenses. Reserves are one month’s principal, interest, taxes, and insurance (PITI). The Automated Underwriting System may require anywhere between one to six-month reserves. The amount of reserves requirement on a home loan depends on how weak the borrower’s financial profile is. Reserves Requirement On Home Loan is also mandatory on multi-unit home purchases.

Why Are There Reserves Requirement On Home Loan?

For the majority of mortgage applications, reserves are not required. However, if the Automated Underwriting System recognizes borrowers with weak financial and credit profiles. Reserves requirement on home loan may be conditioned for weaker credit profile borrowers.

Cases where reserves requirement on a home loan is conditioned on the following types of borrowers:

• has very little and no assets
• down payment is 100% gifted
• borrowers with outstanding collections and charged-off accounts
• borrowers with late payments after bankruptcy and/or housing event
• home buyers buying 2 to 4 unit properties

How AUS View Gifted Funds For Down Payment

HUD allows home buyers to receive 100% gift funds for their down payment. Gift funds for a down payment are not normally looked at favorably by Automated Underwriting System. The Automated Underwriting System likes to see that the home buyer has some skin in the game where they can have their own money. Borrowers with 100% gift funds towards their down payment and has $40,000 in a retirement account in his or her own name, then the chances of the Automated Underwriting System requesting reserves is not likely. However, if borrowers have credit scores under 600 and no retirement funds or any other account with their own funds, then the likelihood of the Automated Underwriting System conditioning reserves is likely.

The Decision of Renters to Become Homeowners

First Time Home Buyers are often given advice by family members, realtors, friends, and colleagues when they start the home buying process to have reserves for a rainy day.

First-time homebuyers need to consider many factors when they decide in purchasing a new home. Just having a minimum down payment and closing costs is not the only factors that are involved. First-time home buyers should also consider reserves in the event if something might go wrong.

Many times, lenders do not require reserves just for first-time homebuyers. There are times where lenders will require reserves for first-time homebuyers if they have less than perfect credit. Manual Underwriting requires one month of reserves. For home buyers buying a three or four-unit residential property, there are mandatory reserve requirements.

For three and four-unit home buyers, cash reserves of up to 6 months of the following:

• the home’s monthly principal
• interest
• taxes
• homeowners insurance

The above is referred to as PITI.

Mortgage insurance premium might be required depending on whether the home buyer is getting a conventional or FHA multi-unit property mortgage loan.

When Reserves Requirement On Home Loan Is Required By AUS

As mentioned earlier, reserve requirements vary anywhere between one to six months. One month’s reserves are one month of principal, interest, taxes, and insurance as well as homeowner association dues if applicable. If the mortgage loan applicant gets 100% gift funds and has poor credit scores, the Automated Underwriting System may require reserves. Reserves cannot be gifted. Reserves need to be the mortgage applicant’s own funds. What happens if the mortgage applicant has no reserves? Borrowers with automated approval per DU FINDINGS and the AUS conditions reserves, those reserves need to come from their own funds and cannot be gifted. Borrowers who do not have their own funds for reserves, then mortgage loan originator can see if he can run LP FINDING, the Automated Underwriting System of Freddie Mac.

There are times when Fannie Mae conditions for reserves and Freddie Mac does not and vice versa.

Fannie Mae And Freddie Mac Reserves Guidelines

Freddie Mac may not require reserves. Fannie Mae and Freddie Mac have their own separate guidelines.  Borrowers conditioned for reserves from both Fannie Mae and Freddie Mac mortgage loan originators may downgrade automated approval to a manual underwrite. Manual Underwriting is where the mortgage underwriter will manually underwrite mortgage loan applications.

Creative Solutions To Reserves Requirement On Home Loan

Creative ways of getting reserves may be by adding borrowers’ names to a family member’s bank account. It now becomes a joint account with a family member and yourself. Adding a name to a family member’s account often gives immediate assets where you can claim is a joint account holder and have funds in a separate bank account. Reserves are recommended for home buyers. Being homeowner is a huge responsibility. Homeowners no longer can depend on landlords for repairs. Maintenance costs money. However, in the event, the HVAC system breaks down or appliances break down, these are high-cost repairs. Although lenders do not ask for reserves, always put away a portion of income aside for reserves in the event of an emergency.

Home Inspection

Most home buyers hire a home inspector and have a home inspection done on the home they are purchasing.

• A home inspection is highly recommended for all home buyers
• However, a home inspection is not a home warranty for future potential repairs that owners can encounter with home
• The home inspector will only inspect the current condition of the home
• Make sure everything is in working condition
• Make sure there are no imminent faults with the home and its mechanical systems
• A home inspector does not have a crystal ball

Inspectors cannot predict the longevity of the furnace, air conditioning units, appliances, well and septic.

What Does Homeowners Insurance Cover

Homeowners insurance does cover major issues such as the following:

• Fire
• Vandalism
• Theft
• Flood

Homeowners do not cover wear and tear issues related to home such as following:

• HVAC repairs
• Well And Septic
• Appliances
• Roof Leaks

The above repair items can cost thousands of dollars and homeowners should have reserves.

Mortgage Reserves Recommended For Homeowners

Home Buyers purchasing a home should have several months of reserves in the event something does go wrong.

• No matter how great of a shape the home is in, things can always go wrong
• Homeowners can have a car breaking down where it costs several thousand dollars for repairs
• This may impact paying mortgage payment on time

Case Scenario Where Reserves Could Have Come In Handy

One of my borrowers has closed on their home last August in Northern Illinois.

• They were first time home buyers and purchased an older home
• Like most first time home buyers, they barely met the cost for the down payment and closing costs for their home purchase
• They were so excited about their home purchase that they were both working overtime and side jobs so they can purchase new furniture and remodel their homes
• Christmas came and went and like most consumers, they maxed out their credit cards
• As many are aware, the Midwest went through a cold spell with weeks of sub-zero temperatures
• Unfortunately, their furnace broke down and their pipes in their basement froze and pipes broke
• The repairs were several thousand dollars and they had no reserves
• They did not have family or friends who have the $3,000 they needed to do the repairs
• To top it all, both of their vehicles needed repairs as well
• They could not have access to their credit cards since they maxed out their credit cards
• Fortunately, they worked things out by working out payment arrangements with the plumber and HVAC company and got a payday loan

Situations like these do not happen too often but do happen.

• Being a homeowner comes with responsibilities and you can no longer rely on the landlord if the home needs emergency repairs
• Although mortgage lender does not require reserves, you should always have reserves in the event of such emergencies

Lenders Requiring Mortgage Reserves

If the Automated Underwriting System requires mortgage reserves, borrowers need to provide it. Mortgage Reserves cannot be gifted. Down payment and closing costs can be gifted but not mortgage reserves.

One month’s reserves are equivalent to one-month housing payment which are the following breakdowns:

• Principal
• Interest
• Property Taxes
• Homeowners Insurance

The above is also referred to as PITI.

There are many more benefits to being a homeowner versus a renter for those who are planning on not relocating in the next three to five years. Home Buyers can qualify for mortgages with bad credit and high debt to income ratios. There are times where the Automated Underwriting System will require Reserves For Homeowners. Non-QM Loans and bank statement loans for self-employed borrowers require reserves.

Cases Where Reserves For Homeowners Are Required

Automated Underwriting System will state whether borrowers require reserves on government and conventional loans.
This is especially the case for mortgage loan applicants with the following:

• Low Credit Scores
• Prior outstanding collections and charge-off accounts.
• Late Payments after bankruptcy and/or foreclosure
• High debt to income ratios
• Purchase of multi-unit properties

Buying Versus Renting

There are many benefits of buying a home versus renting a home.

• Home Buyers can qualify for a mortgage loan with little money down and can have low credit scores

Having Reserves For Homeowners is considered as a compensating factor under the eyes of a mortgage lender.

• In many cases, a renter can convert to being a homeowner with very little money down
• Their monthly housing payments can be the same as being a renter and in some cases
• Their housing mortgage payment can be lower than their monthly rent payments
• Another major advantage of being a homeowner versus a renter is that the homeowner has the potential of accumulating equity in their home as time passes
• This is because a portion of their mortgage payment gets applied towards principal
• Home prices have dropped to historic lows due to the real estate and credit meltdown of 2008
• Home values have been recovering since 2011
• Chances of appreciation are on the homeowners favor if they buy homes at today’s low values
• There are many parts of the country where home values are consistently increasing year after year
• One major disadvantage of being a homeowner is that homeowners need to maintain their home
• They no longer have landlords to depend on when things like furnaces, air conditioners, appliances, and fixtures break down, you as a homeowner are responsible for the repairs

Cash reserves for homeowners are highly recommended whether the lender requires it or not.

Certain Loan Programs Require Cash Reserves For Homeowners

Besides government and conventional loans, there are other loan programs where lenders will require Cash Reserves For Homeowners. First Time Home Buyers purchase mortgage loans, bad credit home loans, high debt to income ratio mortgage loans, regular conventional and standard mortgage loans may require Cash Reserves For Homeowners if AUS requires it. The majority of lenders do not require cash reserves for homeowners unless required on Automated Underwriting System. Condotel lenders will definitely require cash reserves for homeowners. Non-QM Lenders and Jumbo Lenders will most likely require it.

Cash Reserves Required For Portfolio Condotel Financing

A condotel mortgage lender will require one-year cash reserves for homeowners. The cash reserves for homeowners include principal, interest, taxes, insurance, homeowner association dues, and other monthly housing fees. Condotel lenders require that the cash reserves for homeowners be at least three months in cash:

• The remaining nine months in liquid assets such as stocks, bonds, and/or retirement accounts

Cash Reserves For Homeowners Always Recommended Even Not Required By Lenders

For other lenders, cash reserves for homeowners are normally required but I strongly suggest that homeowners have a cash reserve fund for their own protection. Homeowners who live in the Midwest or places with cold winters can have furnaces go out during the middle of winter. These repairs may cost several thousand dollars. Well and septic can break down. These breakdowns can cost thousands of dollars.

Home Inspection

A home inspection is highly recommended. Home Inspections are not required by lenders. However, a few hundred dollars spent on a home inspection is well worth its money.

• Electrical, plumbing, and heating/air conditioning mechanicals can be quite costly to repair
• Homebuyers will want to avoid is purchasing a home that has signs of problems with high ticket items

Appliances and well and septic systems will cost thousands of dollars for repairs.

How Lenders Require Cash Reserves For Homeowners

Reserves cannot be gifted. It needs to be the borrower’s own funds. Again, Automated Underwriting System and/or lenders will require cash reserves from borrowers who pose a higher risk factor. Home Buyers who have further questions on this topic, please contact us at Gustan Cho Associates at 1-800-900-8569 or text us for a faster response. Or email us at gcho@gustancho.com.

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