Do you know about the reserve requirement for people who are buying any home beyond your primary residence?
I am sure you know that the mortgage process is complicated and full of paperwork. Unfortunately, I have to tell you it only gets worse with the more houses you buy.
Not only do you have to qualify for the new house, you have to prove that you can still be responsible for the old houses. Some of the requirements are easy such as just providing a copy of all the leases (writing a kick booty lease) to your old houses in your portfolio. Unfortunately it doesn’t end there!
As discussed in the following posts: Mortgages Un-Mystified, Mortgages Made Simple, and How to Strategically Choose a Loan, there are lots of different loan options.
For your first loan you probably used the FHA, USDA, or VA loan. Those are amazing programs available to the first time home buyer. Unfortunately, except for the VA loan, they cap out at one loan.
As previously discussed, the conventional 5% loan is amazing. More often than not the 5% is still more money than you had to put down on your first loan. So now that you are looking to purchase a second (or third, etc.) house, you have to come up with even more money!
Enter Reserve Requirement
This only happens when you are buying more houses beyond the one you currently live in. So first, congratulations are in order. You were successful enough to want to do this again, or in my case again and again and again 🙂
The reserve requirement is “extra” funds that mortgage companies require you to have in place as an “oh shoot” fund to cover the mortgage.
You are required to have six months of the mortgage amount. So if your mortgage is $1,000, you need to have an extra $6,000 in extra cash. Unfortunately, most mortgages are higher than $1,000. For those of us who have a lot of mortgages this can mean before you know it this number is around five digits. Not only do you have to have a down payment, you also need this reserve amount. This can add up quickly.
This money does not need to be in readily accessible accounts. It only needs to be in a fund that has your name on it. Although we love investing in homes and that is our “primary” form of retirement saving, I am still an advocate of DIVERSIFICATION! The great thing is that your reserve funds can be kept in retirement accounts. We put $800 a month into my husband’s TSP retirement account. This is an amazing way to take care of the low fund costs, market up swings, AND have the money the bank requires for the next house purchase.
Start putting money in your reserve account before you need it. We recently raised our monthly deposit to $800 a month to make sure we have our reserve requirement when it’s needed!
What’s been your experience with the reserve requirement?0
I always assumed your reserves had to be “liquid.” I’ll have to look at my financial situation and make adjustments. I’ve been hoarding a little bit of cash (in nearly no interest bearing accounts) in order to purchase my next owner-occupied investment. Other than HELOCs, do you have another investment medium that allows you to save up for your next purchase?
Unfortunately the only median I know for highly liquid money (ie. downpayment money) is savings/checking accounts. The being said, I try to keep only what is needed for the next house “liquid”. Our “protection” right after a “acquisition” is credit cards and other less liquid savings. Not the best savings for everyone or even us forever but it works in our high income low expense period of life!
Wondering about your DTI ratio and how that affects applying for mortgages…
Having multiple houses does affect our DTI ration. The key for us is being able to count the rental income. While every broker has been different regarding the source they use to calculate our taxes (taxes, leases, equation unique to the broker, etc), we haven’t had problems having the income count.
Dan Phelps says
If you need cash for repairs, vacancies, upgrades, or anything else why would you put it in a retirement account that isn’t meant to be touched until the age of 60?
I also am so confused on why you would be in such debt to earn such a low monthly cash flow?
Can you elaborate?
I’ve been following your blog for a couple months and am a fan of yours. I just don’t see how these numbers and lack of accessible cash add up and make sense for an investor.
Elizabeth Bennett Colegrove says
Great to connect. Our post “Bare It All” October Monthly Rental Income report illustrates our monthly earnings. Based on our october numbers when we had no expenses we earn $1808 a month and our principle pay down is $1633. Therefore our combined monthly cash flow potential is $3,441. While that is the best case scenario and most months are significantly less for us this cash flow is worth it. The actual cash that we earn $1808 goes into a savings account to be used for the next house purchase, repairs etc.
The confusion over the reserve accounts is in regards to the use. The bank requires you to have a large reserve fund for each rental to illustrate the opportunity to get through tough moments.. Most banks in my experience has required 6 months of mortgage, insurance, tax and HOA funds. When you get to 8 houses like ourselves that can mean a huge amount of money. More money than we would typically keep for repairs, vacancies, etc creating a lost opportunity cost.
That is where our retirement accounts. Instead of having to leave these funds in low earnings accounts in order to qualify for another loan, we are able to use our high yielding retirement funds. For us our personal preference is for our funds to stretch and grow every penny to its fullest.