Can Retirement Funds Be Used as Cash Reserves for Mortgages?

It’s a common belief that buying a home requires saving up enough money for the down payment and closing costs first, but some homebuyers find that they need more than this. They need cash reserves as well. This isn’t money you’ll have to pay out of pocket, but it does have to be in your possession or easily accessible by you as of your closing date, and sometimes as early as when you apply for a mortgage. The requirement can depend on what kind of property you’re purchasing, the type of loan you’re taking out and your credit history.

Your lender might want some reassurance that you’ll be able to make your new mortgage payment – including taxes and insurance – if everything goes south after you close on your loan. You might lose your job, for example, or suffer a serious accident or illness that affects your income.

Some lenders want to see that you have bank deposits or other relatively liquid assets available to you in this event. You can easily grab that money and use it to meet your mortgage liability until life straightens out. It’s money in addition to the cash you’re putting down at the closing table.

Homebuyers who are purchasing a personal, primary residence are typically exempt from the mortgage reserves rule, at least if they have somewhat decent credit and their loan-to-value ratio ­­– how much of their home’s value they’re borrowing – is acceptable. You can divide your mortgage amount by your property’s appraised value to arrive at the LTV percentage. The lower, the better.

A credit score of less than 660 or a markedly high LTV ratio will generally result in a mortgage reserves requirement. These indicators make you more of a credit risk, and lenders might want some extra reassurance that you won’t default on the loan.

Ironically, cash-out refinances can sometimes trigger a mortgage reserves requirement. Would you need to refinance for extra cash if you already had available money sitting in the bank? Regardless of the situation, the lender may view a cash out refinance as a potential risk. Purchasing or refinancing a second home or rental property can require mortgage reserves, as can buying a property with more than two units, although duplexes are generally OK.

There are no hard, fast and universal rules. It can vary by lender. Federal Housing Administration, U.S. Department of Agriculture and Veterans Affairs loans generally don’t require reserves under their qualifying rules.

Mortgage reserves aren’t really a bad thing if you think about it. Yes, most homebuyers find their cash reserves seriously depleted after coming up with a down payment and closing costs, but they’d most likely feel better and more comfortable about the whole transaction if they knew they also had some cash in the bank in case of emergency.

And lenders feel better and more confident, too, even when reserves aren’t required. You might find that you get better loan terms if you have some reserves, particularly if your credit situation is marginal. Cash reserves might get you qualified if your credit is iffy enough that you’d otherwise be denied the mortgage. In mortgage terminology, cash reserves are referred to as a “compensating factor.”

You might have some wiggle room when it comes to the definition of “cash” reserves. That 401(k) plan or other retirement fund that you’ve been contributing to for years can count under some circumstances. You must be able to verify your balance, pretty much at a moment’s notice, and only your vested funds are considered to be reserves.

This is the portion that’s yours, no questions asked, if you left or lost your job tomorrow. It’s “accessible.” Fannie Mae retirement asset rules allow for 401(k) loans in some cases if the loan is secured by the plan.

Some lenders want the account to be fully vested, but others will accept the portion that is vested, which means the money you contributed yourself. Remember, you don’t actually have to withdraw the money – it just has to be there. Fannie Mae retirement income rules are structured around special provisions for assets that are invested in mutual funds, stocks and bonds.

The amount of required reserves can vary by lender. It’s measured by months: two, four or maybe six months times your monthly mortgage principal payment, interest, property taxes and insurance. For example, you’d need $4,000 in cash reserves if these payments total $2,000 a month and your lender requires two months’ reserves.

Some lenders will add on homeowners’ association fees, and the cash reserves qualification term can extend to as long as six to 12 months if you’re self-employed or already own several other mortgaged or investment properties.