What are Reserves? | Valor Lending Group
Are you wondering what reserves are?
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What are reserves?
In this blog, we are going to discuss reserves and the reason for them in real estate transactions. First, we will provide the definition. Second, we will explain the acceptable forms of reserves. Furthermore, we will tell you when reserves are needed. Finally, we will explain why reserves are needed.
Full definition from the U.S. Department of Housing and Urban defines reserves as follows:
The total of borrower funds minus the amount the borrower has to pay at closing. This includes the cash investment, closing costs, prepaid expenses, any other payoffs, and any expense required to close the loan. These do not include the amount of cash in hand received by the borrower at the close of the transaction or incidental cash received at settlement in other loan transactions, gift funds more than the amount required for the cash investment and other expenses, equity in another the property, and borrowed funds from any source.
In other words, Funds remaining after close in acceptable forms divided by the PITIA (Principal, Interest, Taxes, Insurance HOA).
Acceptable forms of Reserves:
- Checking or savings accounts.
- Investments in stocks, bonds, mutual funds, certificates of deposit, money market funds, and trust accounts.
- The amount vested in a retirement savings account.
- Cash value of a vested life insurance policy.
When do you need it?
Most importantly, every loan is different, and mortgage companies follow different guidelines. Plan to have 1 or 2 months of reserves and, in extreme situations, can extend up to 24 months. Larger reserve requirements are more typical for jumbo loans.
In addition, reserves help to offset credit risk to the mortgage lender. With higher leverage loans, higher loan amounts, individuals with multiple financed properties should expect to see reserve requirements.
Why Reserves?
Reserves are required to help offset any credit risk to the mortgage lenders. Meaning, the higher the risk, the more reserves are needed.
Why does a mortgage lender require them?
First and foremost, lenders want to see proof you can make payments on the loan. The reserves ensure confidence that you have that ability. In addition, lenders require them to show that if you happen to fall into hard times, you have funds to keep the mortgage note current. This lessens the possibility of defaulting on the loan.
Bottom Line:
In conclusion, reserves are required to offset the risk of the lending source and show the ability to make the monthly payment on the loan for a given number of months. Contact me today for additional information.
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