Cash Reserves: Why They Matter When Buying a Home

There’s a lot of money involved in buying a home. It’s likely the priciest purchase you’ll make as a consumer — and you’ll probably need more cash on hand than you realize.

Not only do you have to save for a down payment and closing costs, but in many cases, you’ll need several months’ worth of mortgage payments set aside in cash. Lenders want to know you can keep paying if you lose your job or if your income is reduced.

Mortgage companies call these funds “cash reserves.” Keep reading to learn more about what cash reserves are and why they matter.

Understanding cash reserves

Cash reserves are liquid funds still available to you after your down payment and closing costs leave your account that can be used to cover your mortgage payments. The term “liquid” refers to an asset that can be quickly turned into cash, such as a checking or savings account, vested retirement account funds or certain investments.

Your reserves are calculated by how many monthly mortgage payments can be paid with the amount of money you have saved. Monthly payments are counted as:

• Principal
• Interest
• Homeowners insurance
• Mortgage insurance
• Property taxes

Homeowners association dues, leasehold payments and secondary financing payments are also counted, if applicable.

Why are cash reserves important?

Cash reserves matter to the homebuying process for several reasons, said Barry Zigas, director of housing policy at the Consumer Federation of America in Washington, D.C. For one, when you buy a home, you’re taking on a large, recurring expense in the form of a monthly mortgage payment.

“You can rest easier as a buyer if you have a comfortable cash cushion so that if you have an interruption in income of any kind or an unexpected reduction in hours, you’ll have some reserves upon which you can draw,” Zigas explained.

There are also overlooked expenses that arise when you own a home, such as buying additional furniture and paying for maintenance. Having reserves at the ready will make it easier to cover those costs.

Lenders also care about reserves for obvious reasons — they want to minimize risk.

“It’s a sign of resiliency on the part of the borrower,” Zigas said. “In other words, they would have the ability to weather interruptions and that’s an important compensating factor for other factors in the underwriting.”

Additionally, the amount of cash reserves you have saved could impact your mortgage interest rate.

How much in reserves is required to buy a home?

While there are often no strict requirements, there are general guidelines to follow.

Homebuyers looking to finance their purchase through a conventional mortgage are encouraged to have two months’ worth of mortgage payments saved in their cash reserves, said Karen Hoskins, acting vice president of national homeownership programs and lending at NeighborWorks America, a community development nonprofit in Washington, D.C.

There is no cash reserve requirement for FHA loans. Still, individual lenders may expect to see some reserve funds, so it’s good practice to establish and consistently contribute to your savings.

Zigas recommends that borrowers save as much as they can muster.

“The bigger cushion you have, the safer you’re going to be in your obligation,” he said.

Cash reserves for an investment property

If you’re buying an investment property, you’ll most likely be required to prove to your lender that you have plenty of reserves on standby in the event your rental income dries up.

Be prepared to have at least six months’ worth of reserves saved when you apply for a mortgage to finance your investment property. Your goal is to demonstrate to your lender that you’re able to withstand a rainy day as a landlord.

In some cases, if your credit score and down payment are higher, a lender may require a smaller cash reserve amount.

The bottom line

You shouldn’t be completely draining your savings to become a homeowner. There are many expenses left to consider once you leave the closing table and receive your keys.

That’s why it’s important to have a sizeable amount of funds stashed away in savings. You wouldn’t want to face a financial burden because of a failure to plan ahead on your part.

“It’s important for homeowners to continue a monthly savings plan, even after the home purchase is completed, in order to have cash available when the unforeseen occurs,” Hoskins said. “Delinquent payments are the primary factor that lower credit scores.”

For more guidance, check out our explainer on how to stress less about your mortgage.