Everyone knows about down payments for purchasing a home, but many don’t understand, or have never heard of, reserve requirements.
Every time a lender or bank makes a loan, they assume a certain degree of risk, and the industry has implemented certain requirements and conditions to help offset that risk. The reserve requirement is simply one of those risk-reduction measures.
Reserve Requirements for Jumbo Loans: How Much Cash Will You Need?
What are Reserve Requirements?
Reserves are basically cash or assets that a borrower holds in case of an emergency. Let’s say a lender writes a loan for $1,000,000, but after five years, the borrower loses her job and is unable to make payments, sending the loan into default. The lender would then have to go through foreclosure proceedings in an attempt to recoup some of their money; they almost never recoup it all.
But what if the lender had required cash reserves? If that were the case, the borrower would have been able to make the mortgage payments while they seek to improve their financial standing. While the borrower is looking for new work, she would have the financial resources to pay for the mortgage, keeping the bank happy and allowing her to stay in her home.
Reserve requirements, therefore, are used to reduce the chances of a loan default. If cash reserves are required, the lender will request proof of an amount that equals a specific number of monthly payments. For example, they may require at least six months worth of financial reserves.
So…How Much Do You Need?
To give you an idea of how much you might need, let’s use our mortgage calculator to crunch the numbers on a few different jumbo loan products. To keep things consistent and simple, we’ll assume an interest rate of 4.25% while looking at the reserve requirements for different loans with different total amount of months.
$1 Million Loan
Monthly payment: $7,077
- Two months: $14,154
- Three months: $21,231
- Six months: $42,462
- Nine months: $63,693
- 12 months: $84,924
$1.5 Million Loan
Monthly payment: $10,579
- Two months: $21,158
- Three months: $31,737
- Six months: $63,474
- Nine months: $95,211
- 12 months: $126,948
$2 Million Loan
Monthly payment: $14,081
- Two months: $28,162
- Three Months: $42,243
- Six Months: $84,486
- Nine Months: $126,729
- 12 Months: $168,972
As you can tell, there is a large window of potential reserve requirements, depending on how many months the lender requires and how large a loan you need for the purchase. Admittedly, it’s rare that a lender would require a full year of reserves, but it’s certainly not unheard of.
The Benefits of Reserves to the Borrower
Having cash reserves on a jumbo loan not only reduces risk to the lender, it can also be beneficial to the borrower. First of all, if you bring cash reserves, you are more likely to be approved for the loan. This is obvious, but what’s not obvious is the fact that with large cash reserves you may be able to secure a lower interest rate, saving you lots of money, especially on jumbo loans.
There is also the fact that it reduces your chances of default. You may think that you could never, not in a million years, go through a foreclosure. Unfortunately, so did the millions of people who lost their homes during the financial crisis. You simply never know what direction life can take, and having financial reserves will inevitably reduce the chances, however narrow, of ever experiencing a default on your loan.
Can You Use Other Assets?
Most reserves will be in the form of liquid cash that you can access at any time. Banks often prefer this, as it shows the borrower can easily use that money for payments in the event of a financial emergency. However, your reserves don’t always have to be in the form of cash. In many cases, a borrower will need to use investment or retirement accounts for their reserves, which is perfectly acceptable in most situations. However, because an investment account can go down in value, the lender may only accept a certain percentage of the assets as cash reserves.
For example, let’s say you need $50,000 in cash reserves for your mortgage loan. You don’t have the reserves in savings, so you decide to use your investment account, which is worth $60,000. But the lender will only accept 70% of the asset, which means the $60,000 in investments only counts as $42,000. In this case, you are $8,000 short on your reserve requirements.
Be aware that you may have to provide the account holder’s terms of withdrawal to the lender in order to use assets as your reserves. The lender just wants to see what it will take in order to extract the money, and they want reassurance that the process is not severely limiting or comes with hefty financial penalties.
How to Prove Reserves
Lenders will need you to provide thorough documentation of the cash reserves, similar to how you would prove other factors such as income and down payments. Bank statements covering a recent period are usually required, and statements on the value of assets can be used to document reserve numbers.
Gifts Can Be Used as Cash Reserves for Some Loans
Generating money for closings costs, fees, and a down payment can be difficult enough, but adding a reserve requirement might make it seem impossible. To help make your lending process easier, we offer jumbo loans that allow you to use gift payments for your cash reserves. This can be an extremely helpful way to break the logjam of reserve requirements, as you can get as much as $2 million in financing on a jumbo loan and use a gift to meet the reserve requirements. This will significantly drop the total amount that you need to generate in order to qualify, and could be the difference between being rejected or securing the loan.
If you want to learn more about using a gift payment for cash reserves on a jumbo loan, contact the experts at San Diego Purchase Loans.