Before we answer this question directly it is important to highlight that there is a difference between how much money you should have in reserve when your mortgage closes and how much money you are required to have in reserve.
Depending on your credit score, loan-to-value (LTV) ratio, debt-to-income ratio and other factors you may be required to hold a minimum level of funds as savings in reserve when your mortgage closes. For example, for conventional mortgages, borrowers with lower credit scores and higher LTV ratios may be required to have up to six months of total monthly housing expense in savings at closing.
Reserve requirements also vary by loan program. For example, the FHA, VA and USDA mortgage programs do not require reserves for most borrowers as long as the property you are buying is no more than two units. Other conventional low down payment program, however, may require that you hold several months of reserves.
Property type is another factor that determines a borrower’s reserve requirement. If you are getting a mortgage for an investment or multi-family property, you are required to meet a minimum reserve requirement which may be up to a year of total monthly housing expense.
Review our comprehensive explanation of the reserve requirement for mortgage
Most applicants use funds in their bank account to meet reserve requirements because stocks and bonds are not permissible sources of funds. Lenders also usually review your account statements to verify that the funds have been in your account for at least two months.
Please note that amount of reserves is usually based on total monthly housing expense, which includes property tax, homeowners insurance and mortgage insurance (if applicable), in addition to your monthly mortgage payment.
For example, if your mortgage payment is $1,500, your property taxes are $200 per month and your homeowners insurance is $50 per month, your total monthly housing expense is $1,750. If your lender or loan program require you to hold three months of total housing expense in reserve when your mortgage closes, you would need to have $5,250 in savings.
This example demonstrates the significant financial burden you may be faced with if you are required to meet a reserve requirement to qualify for a mortgage. When you take into account your down payment and closing costs, holding additional funds in reserve can really stretch you financially, especially if you were unaware of the requirement.
In many cases borrowers have saved enough money for their down payment and closing costs but they do not have sufficient funds to meet the reserve requirement. This financial shortage may force them to wait to apply for a mortgage or in a worst case scenario disqualify them altogether.
This is why it is important to understand if you are required to hold reserves well before you apply for a mortgage. Because reserve guidelines vary by lender, loan program and the factors we outlined above, the best thing to do is ask you lender directly if you need to meet a reserve requirement to qualify for the mortgage and loan program you want. The more specific you can be about your mortgage objectives and loan program, the more specific guidance the lender can provide.
We recommend that you have this conversation three-to-four months before you are thinking about getting a mortgage so you can avoid unnecessary surprises and manage your finances accordingly.
Even if you are among the majority of borrowers that are not required to hold reserves, we always recommend that you keep three-to-six months of total housing expense as savings in reserve when your mortgage closes, if possible.
These funds provide a cushion in the event that you face financial hardship. For example, in the unfortunate case that you lose your job, you can use your reserve funds to pay your mortgage, property tax and other expenses. In short, if you have the financial resources, keeping a minimum level of reserves improves your financial security.
On a final note, whether you hold savings in reserve because you are required to or because you decided to on your own volition, after your mortgage closes you have complete discretion over how to use that money. Post closing, the lender cannot restrict or dictate how those funds are spent, although we should reiterate that it usually makes financial sense to keep some savings in reserve if you can afford it.
"B3-4.1-01, Minimum Reserve Requirements." Selling Guide: Fannie Mae Single Family. Fannie Mae, August 7 2019. Web.