When buying investment properties, cash reserves may be required

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Ask a Lender
August 11, 2017 | Updated September 20, 2017


Key Points

Cash reserves for investment-property purchases

  • Lenders may require cash on hand for principal, interest, taxes, insurance and association dues (PITIA).
  • Checking and savings accounts, money-market accounts and retirement accounts can satisfy the cash-reserve requirement.
  • Reserve requirements may increase if you own several investment properties.
  • Borrowers may be required to use the property as their primary residence.

If you’re looking to invest in residential properties with four or fewer units — properties with five or more units are classified as multifamily and are considered commercial transactions — you should be aware of a potential cash-reserve requirement that can impact your bottom line.

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Having a strong income, credit score and down payment aren’t the only factors in qualifying for an investment property loan. Lenders may require borrowers to show proof of cash reserves for principal, interest, taxes, insurance and association dues (PITIA). Lenders often require PITIA reserves to ensure the mortgage payments are made, in cases where the borrower has a temporary loss of income. This does not mean the borrower will need to access these funds to qualify, only that the money exists and is easily accessible. When a one-month reserve is required, for example, you must have enough cash left to pay PITIA for one month.

How to show proof

There are a variety of asset types that lenders will accept when looking at cash reserves. These include checking, savings and money-market accounts; a verification of deposit (VOD); business accounts; stocks and bonds; and retirement assets such as an Individual Retirement Account (IRA) or a 401(k). With retirement accounts, lenders may only consider 70 to 80 percent of the balance as eligible funds.

Save receipts if you’re selling personal assets to acquire cash. Keep the cash in an account for at least two months, a process known as seasoning, so the lender has a paper trail to follow. Gift funds from a friend or relative may not be eligible unless they’ve been seasoned.

Cash reserves are in the lender’s best interest, but they can also be helpful for investors, as it’s risky to borrow money without having remaining liquidity. Investment homes usually have unexpected expenses, as well as regular maintenance costs. Without a reserve, you may run into trouble if mortgage payments and maintenance costs collide, increasing the likelihood you’ll default on the loan.

How much is enough?

Below is a look at PITIA requirements for four commonly used loan programs associated with properties of one to four units.

Fannie Mae, the government-sponsored enterprise, or GSE, recently changed its rules around cash-reserve requirements for these types of properties. Fannie now uses unpaid principal balance (UPB) to calculate the amount of necessary reserves. UPB includes all mortgages and home equity lines of credit (HELOCs) on a property. You’ll need six months of PITIA reserves for the subject property. If you’re a first-time investor, that’s the only requirement. But if you have many investment properties, the expense will go up.

If you own up to four other financed properties, the required reserve includes an additional 2 percent on the total UPB. If you have fix or six other properties, it’s an additional 4 percent. For seven to 10 investments, it’s an additional 6 percent.

For example, you are financing a two-unit property with a monthly PITIA payment of $1,200. You also have four existing investment properties with an aggregate unpaid balance of $400,000. So, the required reserve is $7,200 ($1,200 for six months) for your new property and $8,000 ($400,000 x 2 percent) for your existing properties, for a total of $15,200.

Freddie Mac, the other major GSE, has less-complex reserve requirements. For the subject property, you’ll need six months of PITIA payments. For each additional investment property you own, you’ll need a two-month reserve.

For example, your subject property has a monthly PITIA payment of $1,000, so you’ll need $6,000 to cover six months. You also have two other investments with a combined monthly PITIA of $2,500, so $5,000 is needed to cover two months. Taken together, your required reserve is $11,000.

Federal Housing Administration loans include an important rule: you cannot qualify unless the property is being used as your primary residence. You may live in one unit and rent the others. FHA requires a one-month cash reserve for properties with two units. That requirement is lifted if the loan originator uses the U.S Department of Housing and Urban Development’s automated underwriting system. For properties with three or four units, there is a three-month PITIA requirement on all properties, regardless of the underwriting model.

If you’re a qualified veteran, you can obtain a loan for a two-to-four-unit investment property through the U.S. Department of Veterans Affairs. You must use the property as your primary residence. Rental income, however, may not be counted in your personal-income calculation unless you have prior experience as a landlord.

There are no cash-reserve rules for two-unit properties, although your available liquid assets will be factored into the underwriting equation to determine how large your loan can be. For subject properties of three or four units, the PITIA requirement is six months. And if you already own investments that aren’t secured by the VA, you’ll need an additional three-month reserve for each property.

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