You typically cannot use the equity in one property, even if it is owned free and clear, to meet the reserve requirements for the mortgage on a rental property. Lenders require that you use liquid assets such as funds in a checking, savings or brokerage account or holdings such as stocks, bonds, mutual funds, CDs, money market funds or trust accounts as the source funds for reserves.
Lenders do not permit you to use your homeowners equity to satisfy a reserve requirement because it may take time for you to convert your equity into liquid funds if you are in a financial bind. Even if you have a home equity line of credit on a property, you may not be able to draw down the proceeds you need.
Understanding this guideline is important because the reserve requirement for a rental property can be significant. You are typically required to hold six months of total monthly housing expense, which includes the mortgage payment, property tax, homeowners insurance and homeowners association (HOA) dues, if applicable, as savings in reserve at closing. For example, if the monthly housing expense for a rental property is $3,000, you are required to have $18,000 in reserves to qualify for the mortgage, which is a major financial commitment.
Review Mortgage Reserve Requirements
Additionally, applicants with higher debt-to-income ratios and lower credit scores may be required to hold twelve months of housing expense in reserve. Plus, as we detail below, if you own more than one rental property financed with a mortgage or other type of loan, you are required to hold additional reserves.
Own 1 - 4 rental properties: 2% of the total loan balance in reserve
Own 5 - 6 rental properties: 4% of the total loan balance in reserve
Own 7 - 10 rental properties: 6% of the total loan balance in reserve
Please note that total loan balance referenced above excludes the rental property being financed, which requires six or twelve months of reserves, and your principal residence.
The table below shows rental property mortgage terms for leading lenders near you. We recommend that you contact multiple lenders to confirm their reserve requirements. Shopping lenders is also the best way to save money on your mortgage.
The final point we should highlight is that the requirements outlined above apply to a conventional mortgage, which is the standard loan program offered by traditional lenders such as banks, mortgage brokers and credit unions. Non-traditional lenders such as private money lenders -- also known as hard money lenders -- may offer more flexible reserve requirements, but it comes at a cost.
Private money lenders usually charge significantly higher mortgage rates and closing costs and apply stricter qualification requirements in other areas. For example, most private money lenders apply a lower loan-to-value (LTV) ratio which means you are required to have more equity in your property to qualify.
Review How a Private Money Mortgage Works
Simply put, a private money lender is usually the lender you turn to when you have no other financing option but they can be helpful for borrowers with very specific challenges. As an example, you may be able to qualify for a private money rental property mortgage with limited financial reserves.
If you decide to apply for a private money loan be aware of the much higher interest rate and fees. We also recommend that you refinance the loan with a traditional mortgage as soon as you meet the qualification requirements, keeping in mind any prepayment penalty you may be required to pay.
You can use the FREEandCLEAR Lender Directory to search over 3,900 lenders by location and lender type. For example, you can find private money lenders in your state that offer rental property mortgages.
"B3-4.1-01, Unacceptable Sources of Reserves." Selling Guide: Fannie Mae Single Family. Fannie Mae, August 7 2019. Web.